S. HRG. 108-145

MEDICARE REFORM AND COMPETITIONSEPARATING FACT FROM FICTION

HEARINGBEFORE THE

SPECIAL COMMITTEE ON AGINGUNITED STATES SENATEONE HUNDRED EIGHTH CONGRESS

FIRST SESSION

WASHINGTON, DC

MAY 6, 2003

Serial No. 108-9Printed for the use of the Special Committee on Aging

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SPECIAL COMMITTEE ON AGING

LARRY CRAIG, Idaho, Chairman

RICHARD SHELBY, Alabama JOHN B. BREAUX, Louisiana, RankingSUSAN COLLINS, Maine MemberMIKE ENZI, Wyoming HARRY REID, NevadaGORDON SMITH, Oregon HERB KOHL, WisconsinJAMES M. TALENT, Missouri JAMES M. JEFFORDS, VermontPETER G. FITZGERALD, Illinois RUSSELL D. FEINGOLD, WisconsinORRIN G. HATCH, Utah RON WYDEN, OregonELIZABETH DOLE, North Carolina BLANCHE L. LINCOLN, ArkansasTED STEVENS, Alaska EVAN BAYH, IndianaRICK SANTORUM, Pennsylvania THOMAS R. CARPER, Delaware

DEBBIE STABENOW, MichiganLUPE WISSEL, Staff Director

MICHELLE EASTON, Ranking Member Staff Director

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CONTENTS

PageOpening Statement of Senator Larry E. Craig ..................................................... 1Statement of Senator Debbie Stabenow ............................................................ 2

PANEL I

Abby L. Block, Senior Advisor for Employee and Family Support Policy,Strategic Human Resources Policy Division, U.S. Office of Personnel Man-agement, Washington, DC ........... 3

Walton Francis, Federal Employee Health Benefits Program Expert Consult-ant and Author, Fairfax, VA ...................... ...................................... 11

Robert E. Moffit, Director, Center for Health Policy Studies, The HeritageFoundation, Washington, DC ......................... ................................... 24

PANEL II

Marilyn Moon, Senior Health Policy Fellow, The Urban Institute, Wash-ington, DC.47 .... C..a.r.e.....a.....Rte...ent 47

Joseph R. Antos, Wilson H. Taylor Scholar in Health Care and RetirementPolicy, American Enterprise Institute, Washington, DC ..................................C...... ................... 72

Jeff Lemieux, Senior Economist, Progressive Policy Institute, Washington,DC ............................................................ 91

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MEDICARE REFORM AND COMPETITION:SEPARATING FACT FROM FICTION

TUESDAY, MAY 6, 2003

U.S. SENATE,SPECIAL COMMITTEE ON AGING,

Washington, DC.The committee met, pursuant to notice, at 10:05 a.m., in room

SD-628, Dirksen Senate Office Building, Hon. Larry E. Craig(chairman of the committee) presiding.

Present: Senators Craig, Carper, and Stabenow.OPENING STATEMENT OF SENATOR LARRY E. CRAIG,

CHAIRMAN

The CHAIRMAN. Good morning, and thank all of you for joiningus. As Congress' Medicare discussion enters what may be its crit-ical final weeks, we are here today to examine one of the centralissues in that debate, namely proposals to offer seniors a new arrayof competing health plans offering prescription drugs and otherbenefits not currently available under Medicare.

These approaches, variations of which have been advanced byPresident Bush, Majority Leader Frist, and others on both sides ofthe aisle, would offer all of America's seniors the same kind of first-class, high-quality health coverage now enjoyed by the members ofCongress and over 8 million other Federal employees.

Today's hearing assembles several of the nation's foremost ex-perts on this issue, including the administrator of the Federal Em-ployees Health Benefits Program (FEHB). There has been muchconfusion and indeed disinformation about the implications of add-ing a competitive dimension to Medicare. It is time to sit down andhear candidly from both sides, ask some hard questions, and get tothe bottom of what this approach will mean in terms of access,quality, value, cost, and member satisfaction.

The Medicare Program in place today is a creaky, inflexible, andincreasingly unmanageable system that micromanages the tiniestdetails of medical payment and procedure-including the pricingand regulation of more than 7,000 medical procedures and over 500hospital procedures.

Of course, traditional Medicare can and should remain as an op-tion for those seniors who want to keep it, but I believe that Amer-ica's retirees also deserve access to the better benefits, the greaterinnovation, and the superior coordination of care that a competitiveinsurance environment offers. Members of Congress enjoy all ofthese advantages. Why not our parents? Why not our grand-parents? That is our purpose today, to examine those issues and

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build a record for the Finance Committee here in the Senate andothers directly involved in this as we craft this legislation to re-view.

Before I do that, let me turn to a member of this committee, theSenator from Michigan.

Senator Stabenow.

STATEMENT OF SENATOR DEBBIE A. STABENOW

Senator STABENOW. Thank you, Mr. Chairman.I am pleased to be here today. This is an extremely important

topic, and I appreciate those who are joining us today.I have a slightly different perspective, but I am very interested

in listening to what our witnesses have to say today. I, at home inMichigan, do not hear people asking for more insurance companiesto choose from; I hear them asking to have Medicare work in termsof prescription drug coverage, to be updated, but overwhelmingly,Medicare, which is the only part of our health care system that isuniversal, available to everyone at the age of retirement or for thedisabled, has been a success in providing a guaranteed level ofcare-defined benefit; people know what they are getting; it is sta-ble.

It is interesting, because as we debate the question of choice, weactually set up a number of years ago an option on choice-privatesector HMOs through Medicare+Choice. I believe that those underMedicare have predominantly chosen to stay in traditional Medi-care overwhelmingly.

Interestingly, my mother chose Medicare+Choice and went intoa private sector HMO and had a very good experience except thatthe HMO, the insurance company, dropped Medicare. They droppedMedicare because of funding issues. So that choice was then nolonger available to her.

So when I look at the issues of Medicare as we go along in thisextremely important debate, I intend to raise another set of ques-tions, and that is whether we think health care is importantenough to really fund Medicare and to provide resources for ourhospitals and doctors and home health care agencies and so on, andprivate choices-if people want to go into Medicare+Choice, fine.But what I see in Michigan is that overwhelmingly, people are say-ing we want traditional Medicare, and we just want it to be up-dated to cover prescription drugs, and we want it to work. I am allfor doing away with some of that bureaucracy and paperwork so itis more efficient and less onerous in terms of the paperwork, butI come from a perspective of saying that Medicare has been a greatAmerican success story and has saved a lot of lives, and I am hope-ful that we can continue to strengthen it in a way that will con-tinue to do that.

Thank you.The CHAIRMAN. Senator, thank you.We certainly agree that probably one of the most important

issues that we will tackle this session of Congress is this issue, notonly for the current recipients but for the long-term effect it willhave on our society in quality health care coverage-both thatwhich is realistic in the modern-day health care system and afford-able in relation to the overall costs.

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So that is what we are about today, and now let me introduceour first panel.

The CHAIRMAN. Our first panel this morning will focus specifi-cally on the Federal Employees Health Benefits Program and howit compares to Medicare. Starting us off this morning will be theperson most directly responsible for direction of the Federal em-ployees program, Abby Block, Senior Advisor for Employee andFamily Support Policy at the Office of Personnel Management.

Also testifying-if he arrives-will be Walton Francis, expert con-sultant and author of "Checkbook's Guide to Health Insurance forFederal Employees."

Finally, we are joined-and he has arrived-on our first panel byBob Moffit, Director of the Center for Health Policy Studies at TheHeritage Foundation. Bob and his staff have studied and writtenextensively on the Federal employees' health program as a possiblemodel for Medicare reform.

We look forward to your testimony, and Ms. Block, if you wouldstart, please, we would appreciate it.

STATEMENT OF ABBY L. BLOCK, SENIOR ADVISOR FOR EM-PLOYEE AND FAMILY SUPPORT POLICY, STRATEGIC HUMANRESOURCES POLICY DIVISION, U.S. OFFICE OF PERSONNELMANAGEMENT, WASHINGTON, DCMs. BLOCK. Thank you, Mr. Chairman.May I request that I be allowed to submit my entire statement

for the record, and I will make an abbreviated statement now?The CHAIRMAN. Thank you very much. All of your testimonies

will be made a part of our record.Thank you.Ms. BLOCK. I am pleased to be here today to discuss the Federal

Employees Health Benefits Program. Our Health Benefits Programhas been in operation for more than 40 years. It is an employer-based program and forms an important part of the compensationpackage offered by the Federal Government.

The Office of Personnel Management has developed widely recog-nized expertise in the complexities of arranging health care cov-erage for more than 100 private sector health plans with a coveredpopulation of about 8.5 million people. In 2002, the program ac-counted for $24 billion in annual premium revenue.

The program relies heavily on market competition and consumerchoice to provide our members with comprehensive, affordablehealth care. In 2003, 188 discrete options are being offered by 133different health plans.

An important and distinctive feature is nationwide availability.About 3 million enrollees are in fee-for-service/PPO-type plans, andone million in HMOs. There is an opportunity to enroll in the pro-gram, change health plans, or change enrollment status at leastonce a year during the 4-week annual open season that begins inNovember.

All of the FEHBP national plans except for the Blue Cross andBlue Shield Basic Option offer their members access to all of thecovered providers in their community. But for those providers thathave not agreed to participate in a preferred provider network, themember does not get the advantage of reduced out-of-pocket costs.

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It is clear in our informational materials that the preferred pro-vider benefit is an enhancement over the standard non-networkbenefit. In a typical network arrangement, the provider agrees toaccept a rate of payment lower than billed charges in exchange foradvantages such as more potential patients, expedited reimburse-ments, and other services provided by the plan.

Often, plans monitor the services provide in network to ensurethat their providers are well-informed about current practice pat-terns and new developments in health care delivery. The plan inturn can pass on the benefits it derives from provider participationin the network to members in the form of lower out-of-pocket costswhen they use a preferred provider. Those lower costs are offeredas an incentive to members to choose in-network services whenthey are available.

However, since the Blue Cross/Blue Shield Basic Option providesno coverage for out-of-network services, we negotiated special pro-visions for that option to ensure that coverage would be availableeverywhere in the country.

While all participating plans offer a core set of benefits broadlyoutlined in statute, benefits vary among plans because there is nostandard benefits package. Even where coverage is nearly identical,cost-sharing provisions may differ significantly among plans.

Benefits and rates are negotiated annually, but OPM does notissue a request for bids. Instead, we issue a call letter to partici-pating carriers in the spring that provides them guidance for theupcoming negotiations. Plans remain in the program from year toyear unless they choose to terminate their contracts, typically forbusiness reasons.

Under current law, the window for new plans to enter the pro-gram is essentially limited to HMOs. Unlike the 1980's, when wewere flooded with HMO applications, in the current market, we av-erage about six new plans a year.

Rates are negotiated with the national plans primarily on theirclaims experience. About 93 percent of premium, or 93 cents out ofevery dollar, reflects benefit costs. The remaining 7 percent coversthe plans' administrative costs.

For community-rated plans, rate negotiations are based on per-member, per-month community rate, and adjustments can be madeto that rate based on demographic factors or utilization factors ofour particular group.

Our oversight focuses on key areas of plan performance, includ-ing attention to quality, customer services, and financial account-ability. All of our contracts include mechanisms through which pre-miums can be adjusted based on performance. In addition, all car-riers are subject to audit by the independent OPM inspector gen-eral. As a result of our collaboration with the IG, the program re-covers on average more than $100 million a year.

While the program has a statutory and regulatory framework,key aspects of plan design such as coverage or exclusion of certainservices and benefit levels are in neither law nor regulation. With-in broad parameters set by OPM, plans have the flexibility to de-termine both their benefits package and their delivery system.

Because policy guidance is developed by OPM and provided tothe plans annually, prior to the start of negotiations, policy

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changes can be made quickly in response to market factors. For ex-ample, this past year, we accepted a proposal from one of our plansfor a consumer-driven option that reflects the development of newproducts in a fluid market.

The FEHB Program uses a hybrid approach that shares practiceswith both public sector and private employer health insurance pro-grams. While we believe the program has been very successful overits long history, we are always looking for ways to ensure that itcontinues to reflect the current health care environment, meet theneeds of its members, and service the government in its recruit-ment and retention efforts.

Our survey results are good. About 80 percent of those enrolledin our national plans are satisfied. Our work with the participatingplans, however, on quality improvement is ongoing. We think thatthe FEHB Program is an excellent example of effective public-pri-vate partnership.

Thank you for inviting me to be here today. I am pleased to an-swer your questions.

The CHImRMAN. Ms. Block, thank you very much.[The prepared statement of Ms. Block follows:]

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STATEMENT OFABBY L. BLOCK

SENIOR ADVISOR FOR EMPLOYEE AND FAMILY SUPPORT POLICYOFFICE OF PERSONNEL MANAGEMENT

Before the

SPECIAL COMMITTEE ON AGINGUNITED STATES SENATE

MAY 6,2003

Mr. Chairman and Members of the Committee:

I am pleased to be here today to discuss the Federal Employees Health Benefits (FEHB)Program.

Our Health Benefits Program has been in operation for more than forty years. It is an employer-based program and forms an important part of the compensation package offered by theGovernment, enabling it to recruit and retain individuals who carry out the vital work ofgovernment. The operating philosophy of the Program is competition with a consumer focus, justas President Bush has highlighted in his framework for Medicare reform.

The Office of Personnel Management (OPM) has developed widely-recognized expertise in thecomplexities of arranging health care coverage with more than one hundred private sector healthplans with a covered population of about eight and a half million people including 2.2 millionemployees, 1.9 million retirees, and members of their families. In 2002, the program accountedfor $24 billion-in annual premium revenue. The Director of OPM, Kay Coles James, has madethe FEHB Program a central focus of OPM attention, especially in terms of maintainingcompetition while ensuring that Federal employees and retirees and.their families receive highquality services. Her strategy has been to encourage innovation from the health plans, supporttough negotiations by her contracting staff, collaborate with the OPM Inspector General in hisefforts to detect and control fraud and cultivate a culture of accountability within the FEHBProgram at all levels, and finally to focus on the demand side by working with the health plans tomake sure their members have the information they need to make the right choices about healthylife styles and appropriate utilization ofservices.

FEHB Program Structure

The Program relies heavily on market competition and consumer choice to provide our memberswith comprehensive, affordable health care. In 2003, 188 discrete options are being offered by133 health plans.

An important and distinctive feature is nationwide.availability. No matter where one lives, allmembers may choose from among a dozen options offered by nationwide fee-for-

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service/preferred provider organization (PPO) plans open to all. Some members may electone of the six nationwide plans limited to members of sponsoring organizations, and many maychoose a Health Maintenance Organization (HMO) in their geographic area. About 3 millionFederal enrollees are in fee-for-servicefPPO plans and I million in HMO's. There is anopportunity to enroll in the Program, change health plans, or change enrollment status at leastonce a year during the 4-week annual open season that begins in November. OPM and theparticipating plans provide information on benefits and rates, provider availability, and qualityindicators during the annual open season so that members can determine which plan best suitstheir needs and the needs of their family and make their plan election.

All of the FEHB national plans, except for the Blue Cross and Blue Shield (BCBS) Basic Option,offer their members access to all of the covered providers in their community. But for thoseproviders that have not agreed to participate in a preferred provider network, the member doesnot get the advantage of reduced out-of-pocket costs. Since the fee-for-service plans introducedpreferred provider networks into the Program in the 1 980s, we have always made clear in ourinformational materials that the preferred provider benefit is an enhancement over the standardnon-network benefit offered by the pans. In a typical network arrangement, the provider agreesto accept a rate of payment lower than billed charges in exchange for advantages such as morepotential patients, expedited reimbursements, and other services provided by the plan. Oftenplans monitor the services provided in-network to ensure that their providers are well informedabout current practice patterns and new developments in health care delivery. The plan, in turn,can pass on the benefits it derives from provider participation in the network to members in theform of lower out-of-pocket costs when they use a preferred provider. Those lower costs areoffered as an incentive to members to choose in-network services when they are available. Wehave never guaranteed in-network coverage except in the BCBS Basic Option. Since Basic is anOption in a nationwide plan and it provides no coverage for out-of-network services, wenegotiated special provisions to ensure that coverage would be available everywhere in thecountry.

While all participating plans offer a core set of benefits broadly outlined in statute, benefits varyamong plans because there is no standard benefits package. Even where coverage is nearlyidentical, cost-sharing provisions may differ significantly among plans.

The design of the FEHB Program permits OPM to focus on three key elements: policy design,contract negotiations, and contract administration including financial oversight.

Benefit and Rate Negotiations

While benefits and rates are negotiated annually, OPM does not issue a request for bids. Insteadwe issue a call letter to participating carriers in the spring that provides themn guidance for theupcoming negotiations. The call letter is a strategic tool in setting the stage for negotiations andhighlighting the interests of the Director. In 2002, OPM highlighted coverage for colorectalscreenings in the context of competition for members among the plans. In 2003, OPMhighlighted coverage for preventive services, and sound oversight by the plans of their pharmacybenefits managers. Plans remain in the Program from year to year unless they choose toterminate their contracts for business reasons, including failure to reach agreement with OPM on

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benefits and rates for the coming year. Under current law, the window for new plans to enterthe Program is limited to HMO's. Unlike the 1980s when we were flooded with HMOapplications, in the current market, we average about 6 new plans a year.

Rates are negotiated with the national plans based primarily on their claims experience. About93 percent of premium, or 93 cents out of every dollar, reflects benefit costs. The remaining 7percent covers the plan's administrative costs.

For the community-rated plans, rate negotiations are based on a per member per monthcommunity rate. Adjustments may be negotiated to the base rate for a variety of reasons,including changes to their standard benefits package, the demographics of the Federal group, andthe utilization of benefits by the Federal group.

We, along with all purchasers of health insurance, have experienced significant rate increasesover the past few years. Our increase in 2003 with 11. I percent, which was high, but well belowthe industry average. The increase for CaIPERS, the second largest employer-based program inthe country, was 25 percent. In 2002, our increase was 13.3 percent. In 2001 it was 10.5percent.

Contract Administration and Financial Oversight

Our oversight focuses on key areas of plan performance, including attention to quality, customerservice, and financial accountability. Measures and expectations regarding quality assurance,patient safety, prevention of fraud and abuse, and compliance with accounting standards are builtinto our contracts. Some measures, such as the results of the industry standard consumersatisfaction survey conducted annually, and the accreditation of health plans and providers byindependent accrediting organizations, are reported to our members in both print and electronicformat. Members use the information, often in conjunction with decision support tools that weprovide on our web site, to choose their health plan during.the annual open season.

We began recently to centralize plan performance data in a data repository that facilitatesanalysis by contracting staff. All of our contracts include mechanisms through which profits canbe adjusted based on performance.

In addition to oversight by the contracting office, all carriers are subject to audit by theindependent OPM Inspector General (IG). As a result of the close collaborative relationshipbetween the contracting office and the IG, the Program recovers on average more than onehundred million dollars a year based on defective community rate findings and unallowableadministrative expense or benefit cost findings. Director James views the OPM IG as a centralpartner in maintaining the creditability of the Program in the eyes of employees and retirees. Shehas supported successive increases in the IG's budget to expand his oversight capacity. Thisyear, our call letter telegraphed specifically the Director's interest in working with the IG toreview costs associated with the operation of pharmacy benefits managers in the Program.

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Policy Design

We administer the FEHB Program in a way that mirrors other employer-based health insuranceprograms. We also are in compliance with all applicable Federal laws and meet all the standardFederal accountability requirements.

While the Program has a statutory and regulatory framework, key aspects of plan design, such ascoverage or exclusion of certain services and benefit levels are in neither law nor regulation.

Within broad parameters set by OPM, plans have the flexibility to determine both their benefitspackage and their delivery system. Because policy guidance is developed by OPM and providedto the plans annually prior to the start of negotiations, policy changes can be made quickly inresponse to market factors. For example, this past year we accepted a proposal from one of ourplans for a consumer-driven option that reflects the development of new products in a fluidmarket.

Because our policy is to encourage innovation and private sector initiatives, plans use business-based processes to achieve desired results. For example, when Blue Cross and Blue Shieldintroduced its basic option a couple of years ago, they had to make adjustments to their providerarrangements to ensure members access to a nationwide provider network since the plan does notcover out-of-network services. Other plans take a different approach and guarantee out-of-network benefits only in parts of the country where they cannot develop a strong providernetwork, such as rural areas.

While plans have considerable flexibility to deal with specific issues such as access to services,the FEHB Program, by statute, has a provision for Medically Underserved Areas that ensuresthat Members have access to health care providers. Our fee-for-service plans must pay forcovered services provided by any licensed provider practicing within the scope of his or herlicense, even if that provider is not considered a covered plan provider.

Conclusion

The FEHB Program uses a hybrid approach that shares practices with both public sector andprivate employer health insurance programs. While we believe the Program has been verysuccessful over its long history in offering Federal employees, retirees, and their families qualitycoverage for a reasonable price, we are always looking for ways to ensure that it continues toreflect the current health care environment, meets the needs of its members, and serves theGovernment in its recruitment and retention efforts. While our survey results are relatively good- about 80 percent of those enrolled in our national plans are satisfied - our work with theparticipating plans on quality improvement is ongoing.

We have benefited from close collaboration with the participating health plans and with otherpurchasers. We also work closely with the Center for Medicare and Medicaid Services (CMS),particularly on issues affecting the population we serve jointly, our Medicare-covered retirees.

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We think that the FEHB Program is an excellent example of effective public-privatepartnerships.

Thank you for inviting me to be here today. I will be pleased to answer your questions.

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The CHAIRMAN. Mr. Francis, we are pleased to see that you havearrived, frustrated, I trust, by the traffic of Washington. Let meagain reintroduce you to the committee.

Walton Francis is an expert consultant and author of "Check-book's Guide to Health Insurance for Federal Employees." I thinkI have seen your work on an annual basis.

Please proceed.

STATEMENT OF WALTON FRANCIS, FEDERAL EMPLOYEEHEALTH BENEFITS PROGRAM EXPERT CONSULTANT ANDAUTHOR, FAIRFAX, VA

Mr. FRANCIs. I hope so, Senator. Thank you very much.I want to report to all concerned that there is a disaster in the

North Capitol Street tunnel. It is blocked and not moving andbacked up for miles in every direction. So I apologize for my latearrival.

The CHAIRMAN. I am glad you finally found a way to avoid it orget around it.

Mr. FRANcIs. I would like with your permission to abbreviate mywritten testimony.

The CHAIRMAN. Yes. All of your written testimonies are part ofthe record.

Thank you.Mr. FRANCIS. Thank you.I decided not to talk about the FEHBP as such, but to talk about

how it compares to Medicare from the point of view of both the en-rollee and the sponsor, if you will, the U.S. Government in bothcases. Although the programs are very different in some respectsthe FEHBP as a fringe benefit of employment, and Medicare as aguarantee to older Americans that they will not be impoverished bytheir health care costs-the programs nonetheless are the two larg-est Federal Government insurance programs in terms of lives cov-ered and are very instructive in the lessons they teach.

It is also the case that there seems to be an increasing set ofcriticisms of the FEHBP, mostly dead wrong, some uninformed,some just using phony statistics or whatever, and I thought Iwould lay some of those to rest.

Let me just review very briefly the key point of my testimony.Retirement health care benefits are better in the FEHBP than inMedicare, substantially better. This is obvious to everybody whohas looked at both programs, but it always warrants saying. I esti-mated for this hearing what Medicare would provide if it were aplan offered under the FEHBP as an option for retirees and howthat would compare to what retirees actually get, and not surpris-ingly, I found that the out-of-pocket costs under Medicare areroughly twice as high on average as those under the FEHBP forthat elderly population.

The components of this better coverage are obvious and well-known-catastrophic coverage, prescription drug coverage, and aminor benefit to which I will return, coverage when travelingabroad or living abroad, for that matter.

On access, 99 percent of physicians accept fee-for-service andPPO patients. That means that 99 percent of physicians acceptFEHBP enrollees. Only 96 percent of doctors accept Medicare pa-

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tients. So access is better-sure, 99 versus 96 is not a huge dif-ference, but it suggests that in rural areas and other places wherephysician availability is quite constrained, FEHBP is superior.

Furthermore, FEHBP is everywhere. In every county in America,there are no fewer than 12 plans available to Federal retirees andemployees. In most of the places where Federal employees residein large numbers-not just Washington, DC, although that is obvi-ous, but most of the larger cities around the country-there arefrom 15 to 20 plans available.

Over time, in sharp contrast to Medicare, the FEHBP painlesslyadapts to changes in the health care marketplace. Both of theseprograms, by the way, started vintage 1960. It is not just thatFEHBP has painlessly adopted prescription drug benefits-in fact,they were in the program from the get-go because nobody wouldvoluntarily enroll in a program that did not have prescription drugbenefits even back in 1960-but that those benefits and many oth-ers have adapted over time to reflect the realities of the health caremarket place. For example, 10 or 15 years ago, most of the fee-for-service plans paid roughly 75 percent of your prescription drugcosts, whatever they were; that was the model. The model today istypically a six-tier system in which there are three price levels formail-order drugs and three price levels for local pharmacy drugs,with generics being the cheapest, approved or formulary namebrand drugs the medium-priced spread in terms of copayments,and you pay most of all if you take a non-formulary name branddrug.

The point of this is that had such a benefit been enacted in Medi-care 15 years ago, it would have been that 25 percent option be-cause that is what was common on those days. It would never havegotten changed. I estimate that the six-tier drug benefit systemused in most of the plans in this program saves the program rough-ly $500 million a year. That is a very significant savings, based onacademic research out there that demonstrates that those kinds ofbenefit structures save a lot of money by inducing frugal choices.

Enrollee satisfaction in this program is very high. There is no di-rect comparison with Medicare possible, but OPM, to its credit, wasa pioneer in developing surveys of enrollee satisfaction to assist en-rollees with information on how to better choose plans. They findthat in these fee-for-service plans, 79 percent of participants ratethe plans 8, 9, or 10 on a scale of 1 to 10.

On guaranteed benefits, this program is often criticized becausethe benefits are not written into law-my gosh, you cannot be sureyou are going to get them or something. Well, that is absurd. Theyare guaranteed. They are guaranteed indirectly, and they are guar-anteed in a way that gets the government out of micromanagingbenefit-by-benefit details.

Let me stop there and conclude. This is a very successful pro-gram. It contains many lessons for Medicare reform, and I hopethose can be incorporated as you deliberate this year.

Thank you.The CHAiRMAN. Mr. Francis, thank you very much.[The prepared statement of Mr. Francis follows:]

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TESTIMONY OF WALTON FRANCIS

AUTHOR AND INDEPENDENT CONSULTANT

BEFORE THE SPECIAL COMMITTEE ON AGING

UNITED STATES SENATE

MAY 6, 2003

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Mr. Chairman, and Members of the Committee:

I am delighted to testify before you today concerning the lessons of the FEHBP for Medicaremodernization. In my dual careers and capacities as a consumer advocate and advisor on how tochoose the best health insurance plan (Francis 2002a), and policy analyst advising on governmentpolicy options and reforms, I have long argued that the FEHBP is a superb model for Medicarereform.

A distinguished student of both programs opined several years ago that "the FEHBP hasoutperformed Medicare every which way--in containment of costs both to consumers and thegovernment, in benefit and product innovation and modernization, and in consumer~satisfaction"(Cain 1999). 1 agree. In my testimony I will try to provide data that will support these conclusionsand also dispel misconceptions about the FEHBP.

Benefits. Medicare serves as a lifeline to the elderly of America. Its coverage of hospital and doctorcosts is vital to the economic well being and survival of millions. Yet, Medicare is infamous for itsobsolete, vintage 1960 design. It does not provide a catastrophic ceiling on costs even for those costsit covers. It does not cover prescription drugs (except in rare instances). It does not cover manypreventive services. It does not cover dental services. And, by failing to cover health care costsincurred abroad. (except in Canada and Mexico), it forces the elderly either to forgo retirement traveloutside of North America or to obtain other coverage. Indeed, so deficient is Medicare coverage thatsome ninety percent of its enrollees purchase or have purchased for them some form ofsupplementary insurance.

None of these deficiencies affect the FEHBP. That program was also created vintage 1960, but it haspainlessly evolved over time through the competitive, consumer-driven process that is its centralfeature. In preparing for this hearing, I rated the Medicare plan for its benefit coverage in 2003,compared to typical FEHBP plans. For a retired person without dual coverage I obtained thefollowing results (these data include dental costs and exclude premiums):

Category Medicare FEHBPAverage Out of Pocket $2640 S1,260CostLikely Cost at Expense S12,580 S6,080Level of $84,000

Ceiling on Combined None $5,000 plus orHospital, Doctor, and minus S 1,000Drug costs

These data demonstrate that FEHBP retirement benefit coverage is far superior to Medicare's.I /

There is another significant dimension of benefit superiority. In both programs the great majority ofcommon hospital and physician procedures are covered routinely. However, at the margin Medicarecoverage choices are dictated either by statutory law or by administrative law dictated through theMedicare coverage processes. In the FEHBP, in contrast, coverage choices at the margin are made byindividual plans. This means that consumers can seek out plans that have better coverage forparticular services of importance to Lhem. Acupuncture, cardiac rehabilitation, expensive dentalprocedures, and other services are usually available, at a price, in some available plan. Medicallyproven procedures, such as pancreas-only transplants, are covered in all or almost all FEHBP plans

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but are often covered by Medicare only after years of delay, if ever. And FEHBP plans are free to,and often do, cover services that they would not ordinarily cover at all if these are approved as part ofa case management package tailored to a particular enrollee.

Provider Choice and Access. Medicare is, in a sense, one of the relatively few remaining pure fee-for-service (FFS) medical plans in America. Most private plans either limit provider choices substantiallyor, as is quite common, provide differential cost sharing depending on whether or not the provider is"preferred'. Of course, Medicare is not really fee-for-service since it regulates prices and, indeed,makes it illegal for providers to negotiate higher prices with enrollees and still obtain anyreimbursement (Hoff 1998). The FEHBP national plans almost all allow enrollees to go 'out of plan"and pay only one fourth of a reasonable charge above that level. These plans' reimbursements aremore favorable for "preferred" physicians, but some payment is available whether the physician hasany arrangement of any kind with the insurance company. At worst, the patient pays the bill and thengets reimbursed directly from the insurance company. Every Federal retiree can join health plansthat reimburse him for most of his costs for virtually any physician who accepts privatepatients at all. More physicians are available through the FEHBP than through Medicare.

The Medicare Payment Advisory Commission conducts surveys of physicians and in its most recentreport found that physicians are significantly less willing to accept Medicare patients than privateplan patients (MedPAC 2003). Specifically, in 2002 over 99 percent of physicians accepted privateFFS and PPO patients, but only 96 percent accepted Medicare patients. This is a seemingly smalldifference but if it is your doctor, or the best specialist in town, who will not accept you, it can have amajor effect on your health care. And until recently enacted payment increases, it appeared that theproportion of physicians unwilling to accept Medicare patients was about to rise substantially.

In this context, the FEHBP has asigniftcant advantage over Medicare because ofits multiplicityofplans. Every Federal employee or retiree, no matter where he or she lives, anywhere in Americaor anywhere in the world, has no fewer than twelve plan options from which to choose in 2003.(This includes both "high" and "standard" options offered by the same carrier, since these optionsalways differ significantly in benefits and in premium.)

Federal retirees in areas covered by participating HMOs have additional plans from which to choose.Thus, while a retiree in North Dakota or Wyoming may "only" have twelve plan choices, a retiree inmedium and large size cities in almost all states will typically have several more plan options. In thelarger metropolitan areas, where the great majority ofboth Medicare and FEHBP retirees reside,there are often about 20 plan choices available to Federal retirees.

Benefit Innovation. The importance of plan choices, of course, goes far beyond serving patient needsfor provider choice and benefit options. The fundamental model of the FEHBP, like most services inour economy, relies on competition in attracting consumers as the driving force for qualityimprovements and restraint of costs. For example, plans are free to add, drop, increase, or decreasedeductibles. These are not trivial decisions. Deductibles have substantial effects on consumeracceptance, on premiums, and on health care utilization. Plans that strike thernght balance do bestover time. The fact that wide variations in deductibles persist over time suggests that there is morethan one "right" model.

In fact, most plan benefits are quite stable. Deductibles are not frequently changed. But some benefitsdo change rapidly in most plans. Notable for experimentation and change are plan payments forprescription drugs. Ten or fifteen years ago, most plans either charged a nominal copayment ormodest coinsurance percentage for all drugs. Enrollees were free to go to the drug store of their

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choice. Mail order and formularies were almost nonexistent. In the last decade, with ever increasingspending on drugs--reflecting mainly new drugs with major new therapeutic benefits-plans havevigorously changed their approaches. Today, most plans have a six-tier benefit structure for drugs.There is one set of copayments for mail order, and another somewhat higher set for using preferredpharmacies. Generic drugs cost the enrollee the lowest copayment, preferred name brand drugs on theformulary somewhat more, and other name brand drugs the most. One can only imagine the politicalturmoil and potential for unnecessarily costly or constraining decisions were price controls andformularies to be proposed as features of a Medicare drug benefit. (Perhaps I had better say: just lookat the last several years of political paralysis!) And it is inconceivable that such a benefit, onceenacted into law under the standard Medicare approach, would receive the kind of nimbleevolutionary adjustments used in the FEHBP as plans jockey for the best mix of generosity and costcontrol to attract customers.

Current FEHBP drug benefit structures place both the burden and the opportunity for decisionmaking on the enrollee. They encourage frugality, but allow for medical necessity. They haveevolved virtually without political controversy or legislative or bureaucratic fiat. And theseapproaches to benefit design been proven to keep down drug spending and save both the payer andthe enrollees a great deal in premium costs (Joyce 2002). Based on RAND research, I estimate thatthe annual savings to the FEHBP from current tiered payment systems is somewhere around $500million annually, about 2 or 3 percent of program-wide premium costs, shared by the government andenrollees (Francis 2002b). Adoption and continuing reform of prescription drug and otherbenefits in the FEHBP has been politically and programmatically painless, while saving billionsof dollars over time.

Consumer Satisfaction. Consumer satisfaction is very difficult to measure fairly, and I am not awareof any studies that directly compare Medicare to the FEHBP using elderly persons as the sampleuniverse. However, we have some important information. OPM has innovated in the use of qualityinformation in the FEHBP program, and led the way to adoption of participant surveys. By providingthis information to enrollees, OPM has significantly aided them in plan selection. These surveysfocus mainly on specific dimensions of plan performance, such as getting needed care, how welldoctors communicate, and claims processing, but also measure overall satisfaction. The most recentsurvey information shows that on a scale of I to 10, about 79 percent of FFS and PPO enrollees and63 percent of HMO enrollees rate their plans 8 or higher.

We also have information from the annual Open Season, in which enrollees decide whether to stay intheir plan or ''vote with their feet" by moving to another plan. Each year, fewer than 10 percent ofemployees and fewer than 5 percent of retirees elect to switch plans. The overall level of enrolleesatisfaction with the FEHBP is clearly very high.

A recent Commonwealth Fund Survey of Health Insurance did compare Medicare and privateinsurance generally (Davis 2002). It found, for example, that 85 percent of Medicare elderly ratedtheir plan as good, very good, or excellent. In contrast, "only" 81 percent of those privately insuredand of working age rated their plans as highly. However, these results really prove nothing. It is wellknown that plan satisfaction increases with age of respondent. Younger enrollees are more critical.This largely explains the differential between FFS and PPO ratings in the FEHBP, since the HMOsdisproportionately attract younger enrollees. In the Commonwealth survey, I would interpret an 81percent favorable rating by those aged 19 to 64, compared to 85 percent favorable among those aged65 or more, as showing that private health plans would actually be rated by consumers farhigher than Medicare if available to each age group. After all, both the experts and the elderly

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agree that Medicare's benefit gaps are serious in comparison to private plans, so how could Medicarebe more popular than private insurance if enrollees were given a chance to select better plans?

Guaranteed Benefits. The FEHBP and Medicare programs differ fundamentally in several ways, oneof which is the difference between a "premium support" as opposed to "defined benefit" structure.One recent study argues that the Medicare approach is better because the benefits are "entitlements"that are "protected" because defined in law (Caplan 2000). This line of argument is fundamentallyflawed in three ways.

First, statutorily defined benefits can be taken away whether or not defined as legal entitlements. TheMedicare deductible used to be defined by law at $50 but is now $100. The Congress once enactedprescription drug benefits and then repealed them. Indeed, the Congress amends the Medicare statuteevery year. As the program steadily progresses toward bankruptcy, maintenance of current benefitlevels hardly seems assured. Relatedly, the FEHBP is just as much an "entitlement" as Medicare. It issimply handled a different way. The FEHBP premium level Is "protected" by being defined inlaw and the "entitlement" formula that defines the premium level provides a substantiallybetter than Medicare level of insurance benefits. The entitlement says, in essence, that thegovernment pays 75 percent of the average cost of plans that enrollees voluntarily choose. Indeed,unlike Medicare the FEHBP statute has never been amended to reduce enrollee benefits.

Second, FEHBP benefits are superior to those of Medicare for decades. The "defined benefit" turnsout to be no more than a guarantee for a second rate product, and the allegedly weaker "premiumsupport" guarantee has proven a superior guarantor by actual experience.

Third, both premiums and benefits can be guaranteed in statute without using the "enumerate everybenefit in excruciating micro-managed detail" approach used by Medicare. Enrollees can beguaranteed by law an actuarially reasonable value of benefits, both overall and in broad categoriessuch as hospital or drugs. Within such a constraint(s), plans can make the decisions as to whichdeductibles (if any) to use, where to set deductible levels, where to set copayment and coinsurancelevels, whether or not to tier benefits, which treatments to accept as medically proven, where to setthe catastrophic guarantee level, etc. In fact, this is essentially the way that OPM operates theFEHBP. The FEHBP statute could be amended to make the actuarial fairness and soundness testsexplicit guarantees better than those of Medicare, without changing the program in anyway. The"premium support" model used by the FEHBP has proven to be both better and safer as anentitlement than the "defined benefit" Medicare model.

Consumer Understandinga It has often been alleged that consumers, particularly elderly consumers,cannot handle the complications of a competitive plan system (for an extensive discussion, seeMedPAC 1999). While by definition choice-certainly is more complicated than no choice, there is noevidence that consumer choice poses any more of a problem for health insurance than for any otherproduct or service. The elderly choose their own doctors, their own automobiles, their own foods, andtheir own living arrangements. Any or all of these are as or more complicated than health insurance.

How many consumers of any age understand the innate workings of automobiles--the technologyused in engine, transmission, braking, and other systems? Yet, somehow, through magazine ratings,recommendations of friends, test drives, modest government oversight and regulation, and above allthe pressures of a competitive market place, the elderly are able to select and use cars that areeffective, durable, safe, comfortable, and economical.

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Competitive choice among health plans is certainly facilitated by careful oversight and informationdissemination. OPM has proven to be effective in these matters, and the private market has providedadditional information that consumers and those family and friends who advise them can useeffectively. See the latest CHECKBOOK's Guide to Health Insurance Plans (Francis 2002a, atwww.retireehealthplans.ore), and the OPM Web site at hto://www.ogim.eoviinsure/healtb forthorough and user friendly displays of information.

Confusion in choosing among competing products has simply not been a problem for the millions ofFederal annuitants who, over the years, have benefited from their plan selection decisions. ShouldMedicare be reformed into a pro-consumer choice system, assuring adequate Information willnot be difficult if the OPM approach is emulated, and the private sector encouraged tosupplement government information.

Adverse Selection. Some argue that any form of multiple plan choice will necessarily lead todestructive risk selection and unpredictable exit and entrance of plans-the dreaded "death spiral." Ihave criticized the FEHBP for having no system of any kind for managing risk selection (Francis2002b). In contrast, Medicare ceaselessly searches for improved methods of fine-tuning its riskmanagement features. Reform of the absurd AAPCC (Adjusted Average Per Capita Cost) system wasdelayed for a decade or more because no one could devise a perfect system. The long delayed reformfailed again to correct the fundamental problem that managed health care still does not in fact costhalf again more in Miami than in Des Moines, or in Prince Georges County than in Fairfax County.

There is even a respectable argument that some risk selection is desirable. For example, if peoplewith dental problems tend to join plans with better dental benefits, willingly paying the full marginalcost of their decision, what ethical or managerial principle is violated?

The FEHBP has survived for four decades with no management of risk selection other than thestability inherently produced by its insurance subsidy. A recent study concluded that the program hasalmost no measurable adverse risk selection (Florence and Thorpe 2003). Whatever circumstancesmay lead to the "death spiral", they do not obtain in a plan choice program like the FEHBP.

The Medicare+Choice Experience. Some claim that because Medicare+Choice has had a rocky start,and failed to reduce overall Medicare costs, consumer choice has been tried and has failed. However,under the reimbursement formula used in that program, relying on the fundamentally flawed AAPCCestimates of geographic variability in health costs, and tied to the yo-yo of annual changes inMedicare spending levels, Medicare+Choice never had a chance to perform properly (Gold 2003). Awell designed defined contribution program using rolling averages or all-plan averages and minimalgeographic adjustments (if any) would have functioned far better. In addition, a set of draconian andunreasonable mandates made participation expensive and burdensome for any FFS or PPO plan, andfor most HMOs. One regulatory mandate, for language interpreter services paid by each plan, isillegal in at least three different ways. Incredibly, despite these problems Medicare+Choice stillmanages to attract about 150 plans and some 5 million enrollees, ahout I in 8 Medicare clients.

A program that made it financially infeasible for HMOs in most of the Midwest to participate, andthat has even forced Kaiser plans to withdraw, is a fundamentally flawed program. The FERBPshows far better ways than Medicare+-Choice to implement effective plan choice.

Cost Control. When I last examined cost control in detail (Francis 1993)1 found, to my surprise, thatthe FEHBP had actually controlled costs slightly better than Medicare. I have updated ny analysisand now conclude that the two programs roughly tie.

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Each program has good years and bad years, and these do not correspond in any simple way. Bycareful selection of base year, it is easy to "prove' that one program outperforms the other. Anddepending on whether the comparison covers one, three, five, or ten years, the answer is verydifferent. To get around these problems, I prefer to use the method of multiple rolling averagescovering 10 years. This shows long term performance without the noise that affects shortercomparisons. One needs multiple ten year comparisons because the latest one can be (and usually is)unduly influenced by a particular good or bad base year in one program or the other. The table belowshows my latest results, all taken from publicly available budgetary data covering 28 years (I haveappended the raw data at the end of this testimony).

Ending in Fiscal Medicare to FEHBP 10 Differerce CumulativeYear Year Record Year Record Difference

1985 15% 12% -2% -2%

1986 13% 8% -5% -7P%1987 12% 10% -2% -9%1988 1t% 11% 0% -8%

1959 10% 11% 1% -7%

1990 10% 11% 1% -6%

1991 94 10"h 1% -5%

1992 8% 11% 2% -3%1993 8% 10% 2% .2%1994 8% 8% 0% -1%

1995 8% 9% 1% 0%

1996 8% 10% 3% 3%

1997 8% 7% -1% 2%1998 S% 6% -1% 1%1999 7-. 6% 0% 0%

2000 6% 6% 0% 1%2001 6% 5% -1% 0%2002 5% 5% 0% 0%

. 2003 est 5% 6% 1% 1%

What these data show is that in recent years both programs have had a 10 year average cost increaseof around 5 or 6 percent a year, and that even over the full set of comparisons the programs have onlydiffered by more than a percentage point a few times. The cumulative difference over comparisonscovering 28 years of data is al percent advantage for Medicare. The best way to interpret this trivialdifference is that Medicare has kept costs down better than FEHBP by so little (if at all) that evenafter 28 years there is no measurable difference in overall performance.

I stopped my analysis in FY 2003, because the budgetary projections for 2004 are unreliable for bothprograms. But we have recently learned from the Medicare actuary that there is an unexpectedincrease of 12% in Medicare Part B costs for 2004. Had I been able to obtain later estimates for bothprograms, the FEHBP would likely have outperformed Medicare in the cumulative comparison. In

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summary, the FEHBP and Medicare programs have virtually Identical records over time onkeeping cost increases down.

It should not really be surprising that the records are similar, since both programs operate in thecontext of the American health care system, with the same underlying structure of hospitals, doctors,costs, technological changes, and a myriad of other commonalities.

However, viewed another way, there is a surprise. The Medicare Administrator, he operates a systemof price controls. As the Congress has so amply demonstrated in its recent flip flop attempts to setphysician, hospital, and Medicare+Choice reimbursements at the "right" levels, determined in largepart by the decibel level of the political outcry, price controls can be set arbitrarily within a fairlybroad range. Thus, Medicare could outperform the FEHBP in reducing premium costs throughcutbacks in provider prices and income, through benefit reductions, and through other government-mandated reductions. Health care resources, both human and bricks and mortar, are not in the shortrun perfectly mobile. Thus, the Medicare budget is set ultimately by what the political systemtolerates, not by the market or any objective method.

One recent study claims that "Medicare can be counted on to control per enrollee spending growthover time, mote than private insurers can" (Boccuti and Moon 2003). This study relies on acomparison of Medicare and private insurance payment data derived from National Health Accountsdata provided by the agency that administers Medicare. The data purport to show that since the mid-1980s Medicare has consistently outperformed the private sector in controlling spending oncomparable services (e.g., excluding prescription drugs because these are not covered by Medicare).Unfortunately, the paper fails to explain its methods and does not display the underlying data andhow they are derived, massaged, and interpreted. I am skeptical that the National Health Accountdata really allow for analysis of this kind. Regardless, the conclusion of the paper is wrong, at leastinsofar as it applies to managed competition like the FEHBP. My data on comparative performanceof the FEHBP and Medicare programs over the last 28 years demonstrate that weni-designed healthinsurance programs such as the FEHBP that rely on competing private plans that respond toconsumer choices can and do perform as well as Medicare in controlling costs.

Conclusion. I have attempted to address each of the major areas in which fundamentally differentapproaches to health insurance programs can be compared. On each dimension of performance, theFEHBP is arguably at least equal, and usually superior, to Medicare as currently constructed. Thisdoesn't lead to any simple conclusion as how best to reform Medicare. The issues are many andcomplicated.-And it certainly does not mean that the FEHBP program is perfect--it has manyimportant problems (Francis 2002b).

But there is one fundamental issue that should be prominent in deciding among reform options andalternatives. The Medicare program is overwhelmingly statist. Medicare uses political flat andcentralized bureaucratic process to try and regulate an infinitely complicated trillion dollar health caremarket. Every decision that Medicare makes is necessarily a compromise that is wrong, often deeplywrong, for large numbers of enrollees and providers. Medicare is like a government designedautomobile (actually, we have had two of these: the jeep and the Humvee). Designed by committee,changed too late, final details set by legislative or bureaucratic flat, based on the principal that 'onesize fits all" and the corollary ethical proposition that every one should get an identical benefitbecause anything else is "unfair, Medicare lurches along like Dumbo the elephant (Cain 1999). Andlike the jeep and the Humvee, it fits very few as well as the plan (or auto) they would choose forthemselves, if offered a choice.

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In contrast, the FEHBP uses the mildest forms of government direction and oversight to allow theforces of choice and competition to determine health plan costs, benefits, provider choice,administrative convenience, and a host of details. For example, every single FEHBP plan covershealth care anywhere in the world (HMOs offer care anywhere outside the plan area foremergencies). Why is this? Because very few consumers would voluntarily enroll in a plan that didn'toffer this feature, even if they had no travel plans. If this feature cost a great deal, some plans woulddecline to offer it to their members, seeking to attract the 'stay at home" group. The fact thathundreds of health plans do not act this way demonstrates that the extra costs of this feature are small.Why then does Medicare not offer this benefit? The answer surely lies in bureaucratic inertia andperceived cost. Cost might indeed be high for Medicare due to its inflexible methods ofreimbursement--very few providers around the world would ever agree to regulation by the UnitedStates government, even such seemingly benign regulation as obtaining a provider number. But thatjust begs the question. Why should Medicare feel obliged to regulate foreign providers by Medicaremethods? Which leads us back to bureaucratic inertia, though paralysis might be a better word.

I don't mean to dwell on coverage abroad, which is a far less important issue than prescription drugcoverage and many others. But a program run on the bureaucratic model necessarily fails to dealoptimally with many problems both large and small. Indeed, we all know that the chief impedimentto a Medicare drug benefit is that the Medicare program is a price control program run along lines notseen elsewhere in most of the American economy since World War H. Price controls are anathemanot only to the pharmaceutical industry, but also to all of us who expect that cures for Alzheimer'sdisease (and many others) are likely only from a profit-driven industry free to charge "high prices"without government control.

The choice before the Congress ultimately is between these two models--consumer choice or detailedlegislative and bureaucratic control. By good fortune we have as an example the successfulperformance of the consumer choice model in meeting the health insurance needs of 9 millionemployees and retirees. Surely we can use that model to aid in reforming the Medicare program.

SOURCES

Boccuti, Cristina and Marilyn Moon. 2003. "Comparing Medicare and Private Insurers: GrowthRates in Spending Over Three Decades." Health Affairs, March/April 2003. Copy atwww.healthaffairs.org.

Cain 11, Harry P. 1999. "Moving Medicare to the FEHBP Model, Or How To Make an ElephantFly." Health Affairs, July-August 1999. Copy at www.healthaffairs.org.

Caplan, Craig F. and Lisa A. Foley. 2000. Structuring Health Care Benefits: A Comparison ofAMedicare and the FEHBP. AARP Public Policy Institute. Copy at www~ao.or.

Davis, Karen et al. 2002. "Medicare Versus Private Insurance: Rhetoric and Reality." Health AffairsWeb Exclusive. Copy at www.healthaffairs.org.

Florence, Curtis and Ken Thorpe. 2003. "Marketwatch: How Does the Employer Contribution for theFederal Employees Health Benefits Program Influence Plan Selection." Health Affairs, March/April2003. Copy at vww.healthaffairs.org.

22

Francis, Walton. 1993. "The Political Economy of the Federal Employees Health Benefits

Program." Health Policy Reform: Competition and Controls, edited by Robert B. Helms.Washington DC. AEl Press.

Francis, Walton. 2002a. CHECKBOOK's Guide to Health Plans for Federal Employees.

Washington, DC. Washington Consumers Checkbook. Retiree version at www.retireehealtholans.org.

Francis, Walton. 2002b. Testimony before the Subcommittee on the Civil Service, Census, and

Agency Reorganization, Committee on Govemment Reform, U.S. House of Representatives,

December 11, 2002. Copy at www.galen.orglnews/Francistestimonv.doc.

Gold, Marsha. "Can Managed Care and Competition Control Medicare Costs." Health Affairs, April

2003. Copy at www.healthaffairs.ora.

Hoff, John. 1998. Medicare Private Contracting: Paternalism or Autonomy? Washington, DC. AEIPress.

Joyce, Geoffrey et al. 2002. "Employer Drug Benefit Plans and Spending on Prescription Drugs."JAMA Volume 288, No. 14 (October 9, 2002).

Medicare Payment Advisory Commission. 2003. "2002 Survey of Physicians About the MedicareProgram". Copy at vwwwmedoac eov.

Medicare Payment Advisory Commission. 1999. "Structuring Informed Beneficiary Choice".

Chapter 4 of Report to the Congress on Selected Medicare Issues, June 1999. Copy atwww.med ac.gov.

DATA ON MEDICARE AND FEHBP COST CONTROL OVER TIME 5/2/2003 Medicare Benefits Paid FEHBP t::Iene Its Paid

Total Ten end of year Total Ten Fiscal Cost per Annual Year Obligations enroll- Cos! per Annual Year Year Part A PartB enrollee increase Average (M) ment(K) enrollee increase Average

1975 $434 $161 $595 $1, 53 3147 $557 1976 $512 $203 $715 20% $2,239 3226 $694 25% 1977 $589 $245 $834 17% $2,600 3297 $769 14% 1978 $680 $288 $968 16% $2,808 3393 $828 5% 1979 $772 $331 $1,103 14% $3,150 3491 $902 9% 1980 $863 $374 $1,237 12% $3,674 3598 $1021 13% 1981 $1008 $446 $1.454 18% $4653 3684 $1263 24% 1982 $1,153 $518 $1,671 15% $4,980 3729 $1335 6% 1983 $1297 $590 $1687 13% $5525 3641 $1517 14% 1964 $1442 $662 $2104 11% $6583 3689 $1,764 16% . 1985 $1567 $734 $2321 10% 15% $6482 3768 $1720 -4% 19116 $1591 $831 $2.422 4% 13% $5,723 3847 $1,488 -14% 1987 $1592 $969 $2561 6% 12% $7714 3909 $1973 33% 1966 $1630 $1,070 $2,700 5% 11% $9 016 40 0 $2,248 14% 1989 $1765 $1158 $2923 8% 10% $10 169 4050 $2,511 12% 1990 $1,970 $1262 $3,252 11% 10% $10922 4041 $2,703 6% 1991 $2009 $1381 $3,390 4% 9% $12657 4077 $3104 15% 1992 $2,315 $1445 $3760 11% 6% $14,024 4074 $3442 11% 1993 $2,546 $1,524 $4070 8% 8% $14,546 4077 $3568 4% 1994 $2,763 $1656 $4,441 9% 8% $15216 4096 $3,715 4% 1995 $3,063 $1,788 $4,851 9% 8% $15515 4053 $3628 3% 1996 $3,289 $1867 $5,156 6% 6% $16,146 4159 $3683 1% 1997 $3569 $2054 $5623 9% 8% $16557 4133 $4,006 3% 1996 $3493 $2,066 $5559 -1% 8% $17,161 4120 $4,165 4% 1999 $3,328 $2146 $5474 -2% 7% $18,654 4123 $4524 9% 2000 $3190 $2370 $5560 2% 6% $19662 4084 $4.814 6% 2001 $3,408 $2652 $6,060 g% 6% $21,143 4075 $5,188 8% 2002 $35BB $2777 $6365 5% 5% $22620 4046 $5,640 9%

2003 est $3,66 $3,024 :>6,691 5% 5% $28,461 4057 $6,522 16% Notes: FY 2004 estimates excluded because of recent arinouncement t at Medicare costs will far exceed b\Jdget estimate. FEHBP amounts do not equal annual premium announcements because of reserve payments and Open Season shifts. Sources: FEHBP data from U.S. Budget Appendix since FY 1982 and, for earlier years, OPM annuallnsurence Report,

12% 8%

10% 11'Yo 11% 11% 10V. 11% 10% 8% 9%

10% 7% 6"/0 6% 6% 5% 5% 6V.

Medicare data before FY 1999 from Green Book; from 1999 forward from HHS Budget in Brief. Some years interpolated (italics).

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The CHAIRMAN. Now let us turn to Bob Moffit, Director of theCenter for Health Policy Studies at The Heritage Foundation.

Bob, welcome to the committee.

STATEMENT OF ROBERT E. MOFFIT, DIRECTOR, CENTER FORHEALTH POLICY STUDIES, THE HERITAGE FOUNDATION,WASHINGTON, DCMr. MOFFIT. Thank you very much, Mr. Chairman and Senator

Stabenow.I am the Director of the Health Policy Studies Center at The

Heritage Foundation, but the testimony I give today is my own anddoes not represent the views of The Heritage Foundation or its offi-cers or its trustees.

First of all, I want to say how deeply appreciative I am for theopportunity to appear before this committee and talk about thisissue. Let me also say that for me, this is not merely an academicexercise. I was a Federal employee. I was involved in the Federalemployee system. I was a deputy assistant secretary at the Depart-ment of Health and Human Services during the Reagan Adminis-tration, and I also served as an assistant director at the Office ofPersonnel Management, the agency that Abby Block representstoday. I am very familiar with that agency and worked there forseveral years.

But it was not until 1992 that my colleagues at The HeritageFoundation persuaded me-"persuaded" is the appropriate word, Isuppose-to write about the Federal Employees Health BenefitsProgram and its potential for policy guidance for broader healthcare reform, including reform of the Medicare Program.

The central policy question facing the Congress and the Nationis whether the Medicare Program as it is today can absorb the de-mographic shock of the baby boom generation and continue to de-liver high-quality medical care in an economically efficient fashion.That is the real nature of this debate. I do not think that it can.

Having said that, that does not mean-I repeat, it does notmean-that we should rely on a private sector model of health caredelivery, nor does it mean that we should rely upon the MedicareChoice experience for delivery of medical services.

The best serviceable model is in fact a public-private partnership,and that means both elements, both the public sector and the pri-vate sector working together. As Abby Block has said to the com-mittee, the best serviceable model we have of this kind of public-private partnership is the Federal Employees Health Benefits Pro-gram. It is a program with which we have 43 years of experience.It is characterized by choice, patient choice, market competition,and very solid consumer information and satisfaction.

As Mr. Francis has pointed out, every Federal employee, whetherthey are retirees or active employees, whether they live in urbanareas or rural areas, has a choice of at least 12 plans nationally.Most of these plans are fee-for-service plans and PPO plans. Theyare not HMOs. You can enroll in an HMO; if you want to enrollin an HMO, that is your choice. Thirty percent of all enrollees doso.

There is no reason why Congress could not establish a similarstructure of national plan choice for future Medicare enrollees. I

25

would suggest two things in transition to a new Medicare Program,two areas where Congress could actually improve on the programmore effectively.

First, it could integrate private retiree health insurance into thenew system, creating a seamless continuity of coverage and care.If individuals have had a good experience all of their working liveswith a private plan, and they want to carry that private plan intoretirement with them as their primary coverage and keep the doc-tors and specialists they already have, they should be able to doso and get a government contribution to offset the cost of that plan.

Another recommendation I would make is that Congress couldalso make sure that new consumer-driven options similar to whatAbby Block has mentioned in the FEHBP are also easily accessibleto retirees who want them, including medical savings accounts,health reimbursement accounts, or other forms of health accounts.Right now, Mr. Chairman, there are 1.5 million Americans withsuch options, and there are prospects for significant growth in thatmarket, and people should be able to take advantage of that intheir retirement.

As Mr. Francis has pointed out, the FEHB provides a benefitspackage which is clearly superior to Medicare in every conceivableway. It has a reasonable record of administrative cost-one percentfor OPM in administrative costs and roughly 7 percent for the car-riers. It allows and encourages innovation in health care delivery.It provides a regulatory system that focuses primarily on consumerprotection rather than provider regulation. Under its statutory au-thority, OPM is to contract with health plans that are licensed inthe States, that guarantee basic benefits, that charge rates that arereasonably and equitably reflecting the costs and the benefits.

The FEHB model provides for a regulatory environment that islight and flexible and does not demoralize doctors or other medicalprofessionals.

Under Section 8902 of Title V of the U.S. Code, OPM is author-ized to prescribe "reasonable minimum standards" for health carebenefits for plans and carriers. The FEHB regulatory system pro-vides a level playing field for competing health care plans. TheFEHB model also gives enrollees the ability to act on solid informa-tion in selecting plans as well as doctors, hospitals, and medicaltreatments.

I think that for the baby boomer generation in particular, this iscritically important. In the 21st century, information technologywill accelerate and become an instrument for increasingly sophisti-cated personal decisionmaking. Right now, about 70 percent of allAmericans in the work force during their prime years from theirtwenties to their fifties use computers and have access to the inter-net. According to the Department of Commerce, Americans who usecomputers and the internet when they are younger are likely tocontinue to do so as they age.

There is no reason why 21st century retirees, particularly thebaby boom generation, should not be able to take advantage of rap-idly advancing information technology for periodic health care com-parisons and even more detailed comparative information on qual-ity, on service, on outcomes, on the availability of evidence-basedmedicine among providers.

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Mr. Chairman, the other important point here is that the FEHBmodel provides for a financially stable program. The FEHB trustfund is unified. Its administration is comparatively simple. Thepremium income and disbursements in the trust fund are easilytracked; the fund's income is routinely subjected to congressionalaction and oversight. If for any reason there is a need for a supple-mental appropriation for the FEHB trust fund, Congress can anddoes provide it. In this respect, the FEHB trust fund model is supe-rior as a mechanism for monitoring the solvency and ensuring thefinancial stability of a modernized Medicare system.

Mr. Chairman, that concludes my remark. My only point is thatwe have 43 years of experience with this program-43 years of ex-perience. We know its strengths, we know its weaknesses, we knowwhere it can be improved, and we know how to make it better. Theimportant point is that with this record of success, we have a tre-mendous opportunity to build a superior health care system for theretirees now and in the future, particularly the baby boom genera-tion that is going to retire in just 8 years.

Thank you.[The prepared statement of Mr. Moffit follows:]

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OCngufssionim Testinrny

TESTIMONY BEFORE THESENATE SPECIAL COMMITTEE ON AGING

TESTIMONY

A ROAD MAP TO MEDICARE REFORM:BUILDING ON THE EXPERIENCE OF THE FEHBP

May 6,2003

Robert E. Moffit, Ph.D.Director, Center for Health Policy Studies

The Heritage Foundation

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Mr. Chairman and Members of the Committee:

My name is Robert E. Mofflt I am the Director of the Center for Health Policy Studies atThe Heritage Foundation. In that capacity, I supervise a staff of analysts who examinefederal and state health care policies and programs, as well as developments in the privatehealth insurance markets. The testimony I give today is my own and does not necessarilyrepresent the views or opinions of the Heritage Foundation, its officers, or its trustees.

I deeply appreciate your invitation to appear and discuss Medicare reform and the lessonswe can learn from the experiences of the Federal Employees Health Benefits Program(FEHBP), the largest group health insurance program in the world. In this connection,neither Medicare nor the FEHBP is for me simply a matter of academic interest As aformer federal employee, I served as Deputy Assistant Secretary for Legislation at theU.S. Department of Health and Human Services (HHS) during the ReaganAdministration and also as an Assistant Director for the U.S. Office of PersonnelManagement (OPM), which has administrative responsibilities for the FEHBP. It was notuntil 1992, however, that my colleagues at The Heritage Foundation persuaded me topublish on the FEHBP, focus on its unique features of consumer choice and marketcompetition, and outline key lessons for a broader reform of the American health caresystem. '

THE FUTURE PROBLEM

Within eight years, the first wave of the 77 million baby-boom generation will start toretire and become eligible for Medicare. This generation's retirement will doubleMedicare's enrollment, dramatically increase Medicare spending and costs, and imposeenormous financial pressures on the Medicare Hospitalization Trust Fund, the generalrevenue fund, taxpayers and Medicare beneficiaries alike.

More important, the retirement of the baby-boom generation will stimulate the greatestdemand for medical services in history. This is not only because of the sheer size of thebaby-boom generation and the volume of services that such a large retiree population willrequire, but also because of the rapid changes in medical technology, the fruits ofadvancing biomedical research, and the expected level of quality of care and service thatthis next generation of retirees will wish to consume.

Today's $271 billion Medicare program is a universal, defined benefit program, financedlargely by today's taxpayers for today's retirees. This, given America's rapidly changingdemographic profile, presents its own formidable financial challenges, as the Medicaretrustees, the Congressional Budget Office, and theiU.S. General Accounting Office havealready described in significant detail to Congress and the public.

But there is an equally, if not more serious, challenge for the Congress, as well as fordoctors, hospitals, nurses, and other medical professionals: How do we assure the cost-effective and efficient delivery of high-quality medical-services to this very diverse andrapidly aging population? Under the current system of Medicare governance, medical

'Robert E. Moffi. "Consumer Choice miHealth Learning from the Federal Employees Health BenefitsProgram," Heritage Foundation Backgrounder No. 878, February 6, 1992.

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benefits, treatments, and medical procedures must be authorized by law or approvedthrough the regulatory regime developed and enforced by the Centers for Medicare andMedicaid Services (CMS). In short, Medicare is governed by a system of detailed centralplanning.

Moreover, beyond the definition and determination of medical benefits, treatments, andprocedures, and the conditions under which such services are to be delivered to Medicarepatients, Congress and the CMS must price more than 7,000 medical procedures offeredby more than 800,000 physicians and other medical professionals; more than 500 hospitalprocedures; and various medical devices and technologies, skilled nursing and homehealth care services. In short, Medicare is also governed by a massive system of priceregulation.

The central policy question facing Congress and the Administration is whether Medicare,as it exists today, can absorb the demographic shock of the baby-boom generation andcontinue to deliver high-quality medical care in an economically efficient fashion. I donot think that it can.

Neither Congress nor the Administration can control the popular and growing demand formedical services. For example, in the area of prescription drugs alone, of the 11.8 percentincrease in drug spending in 2002, 8 percentage points were attributable to the use of newdrugs as well as the expanded use of existing pharmaceuticals for a variety of medicalconditions. 2

In the face of an unprecedented demand for modern medical services, there is no questionthat Congress can control the supply of medical services, and thus the cost of the programitself, simply through tighter controls on reimbursement to doctors, hospitals, and othermedical professionals.

The proposition that the government can control the growth in Medicare spendingthrough the imposition of price controls or caps on overall Medicare spending is anintellectually unimpressive one; of course, it can. But, likewise, there is no reason tobelieve that Congress can impose such controls and cap such spending andsimultaneously accommodate the rising demand for those services without reducing theirquantity or compromising their quality.

THE NEED FOR A SUPERIOR MODEL

If Medicare's current structure of central planning and price regulation is not the bestmodel for Medicare's future, however, it does-not logically follow that conventionalprivate-sector health insurance is a better one.

In the private-sector health insurance market, individuals and families generally do nothave portability or security in their coverage. Nor do they exercise control over the termsand conditions of their benefits. Employers, corporate benefits managers, or managedcare executives often make all of the key decisions over the.terms and conditions ofcoverage, and therefore can create obstacles to their access to physicians and medical

>Rx Spending Growth Slows to Lowest Level in Six Years," Pharmaceuaical Research and Manufacturersof America, Spring 2003.

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specialists, treatments, and procedures. In most instances, individuals and families, whosecoverage is tied to their jobs, cannot "fire" poorly performing health insurance companiesin the same way they can dump poorly performing firms in many other areas of insurancecoverage or in the provision of all other services in an open market.

A Public-Private Partnership. If the private-sector experience cannot yield the bestmodel for a better Medicare program, that does not mean we cannot enter into a public-private partnership that can yield solid results for the next generation of senior citizens.

The best serviceable model of a public-private partnership is, in fact, a governmentprogram. It is the 43-year-old Federal Employees Health Benefits program (FEHBP),which serves 8.3 million federal employees, retirees, and their families, including morethan 172,000 persons who rely on FEHBP as their primary coverage in retirement.Created by an Act of Congress in 1959, the FEHBP is governed under the provisions ofChapter 89 of Title V of the United States Code. It is administered by the United StatesOffice of Personnel Management (OPM) and annually financed through congressionalappropriations. Based on choice and competition, it is a government program older thanMedicare, Medicaid, or most private managed care arrangements.

BUILDING ON THE FEHBP EXPERIENCE

Building on the FEHBP experience, Congress and the Administration can work togetherto create a new and improved Medicare program that is characterized by patient choice,including plan choice in rural areas, market competition, and solid consumer information.Other features of the FEHBP model include an openness to change, administrativeflexibility, stability in the insurance market, and rationality and predictability in thefinancing of care. Specifically:

* The FEHBP model guarantees enrollees, regardless of where the live, a broadrange of health plan choices. The professional literature, including recent surveys ofMedicare beneficiaries, proves conclusively that choice of health plans is highlyvalued and that there is a direct relationship between the choice of a health plan andpatient satisfaction. 3 Not surprisingly, in the FEHBP, enrollee satisfaction is higherthan that found among enrollees in the health insurance industry as a whole. 4

In any transition to a new program, Medicare patients may wish to remain inconventional Medicare, but they should also have the right to pick and choose from adiversity of options, a variety of health plans, the benefits, the doctors and medicalspecialists, and the medical treatments they think are better for them at the prices theywish to pay.

The FEHBP is an excellent model for designing a system based on broad personalchoice. Every FEHBP enrollee, rural or urban, has a multiple choice of national

3For an overview of the recent surveys and the professional literature, see Derek Hunter, "Just the Facts:Health Care Choice and Patient Satsfaction," Heritage Foundation Web Memo No. 259, April 17, 2003, athup l://ww.henrage.org'Research.HealthCarelr259.cfin.4'Ibd

31

health plans.5 Today, there are 12 national health plan options, mostly fee for serviceor preferred provider organization (PPO) options, available to all enrolleesnationwide. About 70 percent of all enrollees are enrolled in fee for service or PPOplans.6

The FEHBP rules governing the participation of health maintenance organizations(HMOs) are very different. HMOs participate at the state level, and the number ofparticipating HMOs, which today cover roughly 30 percent of all FEHBP enrollees,varies from year to year.7 There is no reason, of course, why a reform of Medicarecould not establish a similar structure for national plan options, as well asgeographically based HMOs, for future Medicare enrollees.

In assuring choice, and in restructuring the Medicare program, Congress can improveon the experience of the FEHBP in two key areas:

First, it could integrate private retiree health insurance into the new system, creating aseamless continuity of coverage and care. If individuals have had a good experiencewith a private plan-in their active working life, and want to carry that plan with theminto retirement as their primary coverage and keep the doctors and specialists thatthey already have, they should be able to do so and get a government contribution tooffset the costs of that plan.

Second, Congress can make sure that the new consumer-driven options are also easilyaccessible to retirees who want them. Such options include medical savings accounts,.flexible spending accounts, health reimbursement accounts, or other forms of healthcare accounts. In any case, retirees should be able to take accumulated funds fromthese accounts with them into retirement to use as payment for medical services.Right now there are 1.5 million Americans with such options,8 and there are prospectsfor significant growth.

The FEHBP provides for a benefits package significantly superior to that ofMedicare, beyond prescription drug coverage. Beyond the broad range of healthcare choice, basic FEHBP coverage is typically of greater value than Medicare.According to a recent Congressional Research Service (CRS) analysis, when drugcoverage, home health, and skilled nursing care are factored into the comparativeequation, FEHBP has a total actuarial value that is 28.8 percent more generous thanMedicare.9

5For a discussion of coverage in rural as weU as urban areas, see Nina Owcharenko, "Giving Rural Seniorsa Choice of Health Plans: The FEHBP Model for Medicare Reforn," Heritage Foundation Web Memo No.258, April 17, 2003, at htp:.'/ www.henrage.oriyResearchlHealthCare/wm258. cfm.'U.S. General Accounting Office, Federal Employees'Health Plans: Premium Growth and OPM's Role inNegohoang Benefits, Report to the Subcommittee on International Security Proliferation and FederalServices, Committee on Governmental Affairs, U.S. Senate, GAO-03-236, December 2002, p. 6.'Ibid, p. 7.'See Jon R. Gabel et al., "Consumer Driven Health Plans: Are They More than Talk Now?" Health AffairsWeb Exclusive, at http:i/vww.healthaffairs.org/WebExclusives'GabelWebExcL 112002.htm.9Derek Hunter, "Just the Facts: The Disparity in Value Between FEHBP and Medicare Coverage," HeritageFoundation Web Memo No. 262, April 23, 2003, athup:'vww.herntage. org/ResearchWHealthCare/wm262.cfm.

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Perhaps even more significant is the ability of FEHBP enrollees to secure value formoney. Drug coverage in the FEHBP (all plans have such coverage) provides anexcellent case study. According to analyses conducted by the General AccountingOffice (GAO), health plans in the FEHBP typically contract with pharmacy benefitmanagers (PBMs). These PBMs offer "generally non-restrictive drug formulariesacross a broad range of drugs and therapeutic categories."'0 The GAO found that for14 selected major brand-name drugs sold in retail pharmacies, enrollees were able tosecure discount prices at about 18 percent below what cash-paying customers wouldotherwise have paid; for four selected generic drugs, the discount prices were 47percent below prices paid by cash-paying customers.'1 For mail order prescriptiondrug options, the GAO found that the performance was even more impressive. 12

* The FEHBP has a record of reasonable administrative costs. With a relativelysmall staff, OPM incurs administrative costs that are I percent of the "aggregate costof plan premiums, but generally are less than that amount." 13 The administrativecosts of the major health insurance carriers, the national fee for service and PPOplans, average about 7 percent.

Parenthetically, it is worth noting that Medicare's administrative costs are routinelyassumed to be much lower, running between 1.5 percent and 2 percent annually.Technically, as a percentage of administration to benefits, this is correct. This widelyheld assumption, however, neglects the administrative costs that are routinelyincurred by doctors and medical practices, hospitals and clinics, home health care andskilled nursing facilities in complying with Medicare's regulatory regime andpaperwork requirements.

A 2001 study conducted by PricewatershouseCoopers for the American HospitalAssociation reports that for every hour of care delivered to a Medicare patient in anAmerican hospital, hospital officials typically spend at least a half-hour or morecomplying with Medicare paperwork. Doctors and other medical professionals bearsimilar costs in time, energy, and effort. Every dollar spent on complying with theincreasingly onerous requirements of Medicare's growing regulatory regime is adollar that is not spent on patient care. None of these very real costs, of course, showup in the Medicare budget.

The FEHBP-model allows and encourages innovation in the delivery of healthcare. In a restructured Medicare program, there should be ample room for plans andproviders to innovate and make changes in delivery of medical services, such as the

"David M. Walker, Comptroller General of the United States, "Medicare: Observations on ProgramSustainability and Strategies to Control Spending on Any Proposed Drug Benefit," testimony before theCommittee on Ways and Means, U.S. House of Representatives, GAO-03-650T. April 9,2003, p.

20.

'Jbid, p. 19."2Ibid, p. 20. The GAO analysis revealed that for mail order prescription drug options in the FEHBP, the

prces were 27 percent lower for the selected brand-name drugs and 53 percent lower for the selectedsenerc drugs.

f'These sums pay the personnel costs of OPM actuaries and employees who negotiate with carriers,monitor plans, and generally oversee all aspects of program administration. OPM adds a charge to eachplan's premium to cover these administrative costs." Carolyn L. Merck, The Medicare Program and TheFederal Employees Health Benefits Program: Purpose, Design and Operations, May 26, 1999, p. 34.

33

inclusion of new benefit combinations or increasingly sophisticated coordination ofcare for persons who are chronically ill. Medicare patients should also be able to takeadvantage of the latest in cutting edge technology or medical treatments withoutwaiting literally for years for a central agency to make decisions about coverage, orabout coding for procedures, or payments for these procedures or technologies.

In this respect, also, the FEHBP provides a solid working model. The program is not,strictly speaking, a pure defined contribution system; nor is it a pure defined benefitsystem. It is, in effect, a combination of both. While the law defines categories ofbenefits, such as hospitalization or physician services, that must be included in anyplan wishing to participate in the FEHBP, the specific medical benefits, treatments, orprocedures, including the kind of medical technologies that are available, are largelydetermined by the health plans themselves and subject to the satisfaction of consumerdemand in a competitive market. In other words, the FEHBP provides a structure thataccommodates and encourages innovation.

The FEHBP model provides a regulatory system that focuses on consumerprotection rather than provider regulation. Under its statutory authority, OPM isto contract with health plans that are licensed in the states; that are reinsured withother companies; that offer detailed statements of benefits with definitions oflimitations and exclusions that OPM considers "necessary or desirable"; that chargerates that "reasonably and equitably" reflect the costs of the benefits; and that agree toprovide benefits or services to persons entitled, as OPM determines, under the termsof its contract.

OPM enforces fiscal solvency requirements and makes sure that plans can pay claims.The agency is authorized to levy a surcharge on plans of up to 3 percent of premiumsto establish a contingency reserve fund for the payment of unforeseen claims.

OPM is also solely responsible for the benefits available to federal employees andretirees. Under Section 8902 of Title 5, the terms of any contract between OPM and acompeting plan pre-empt any state or local law governing health insurance or healthplans.

There is no reason why a new Medicare administrative agency could not perform thevery same functions as OPM in a restructured Medicare program.

* The FEHBP model provides for a stable health insurance market. Adverseselection or risk segmentation is normally a concern with a system based onpluralistic, competing health plans with a variety of benefits packages and voluntaryenrollment. The concern is that older and sicker enrollees will congregate in certainplans, drive up the cost of those plans, and drive younger and healthier enrollees out,further driving up costs and premiums with a resultant unraveling of the market.

The FEHBP, however, offers a working model to alleviate this concern. Extensiveresearch on the issue of adverse selection in the FEHBP shows that, in fact theprogram is remarkably stable.14 In the FEHBP, there is no risk-adjustment mechanism

"4Curtis S. Florence and Kenneth E. Thorpe, "How Does the Employer Contribution for the Federal

Employees Health Benefits Program Influence Plan Selection?" Health Affairs, Vol. 22, No.2 (Spring2003). pp. 21 t-218.

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to deal with the problem of adverse selection, yet it is characterized by features that

should gravely aggravate problems of adverse selection: There is no standardizedbenefits package; premiums are governed by a crude form of community rating (older

persons pay the same rates as younger ones); and all plans are required to enrollpersons without regard to their health status.

Professor Kenneth Thorpe of Emory University found, however, that while more than

half of regular active workers and older, Medicare-eligible workers are enrolled in

low-cost health plans, the age distribution is roughly the same across all competing

health plans in the FEHBP: low-cost, medium-cost, and high-cost plans. The researchindicates that the generosity of the subsidy, a government contribution up to 75percent of the cost of the health plan, is enough to encourage younger and healthier

persons to pay extra for the attractive benefits in higher priced health plans.' 5

The FEHBP experience, therefore, has positive implications for Medicare reform,where proposed Medicare contribution formulas for competing health plans wouldlikely be more generous than those in the FEHBP.

The FEHBP model provides for a regulatory environment that is light andflexible and that does not demoralize doctors and other medical professionals.The FEHBP provides a solid working model of regulatory flexibility. Under Section

8902 of Title 5 of the U.S. Code, OPM "may prescribe reasonable minimumstandards" for health benefits plans and for carriers. As the CRS observed in its

comprehensive 1989 analysis of the FEHBP, the legislative language authorizing the

FEHBP gave OPM "broad powers" to administer the FEHBP, and OPM has thus had"wide latitude to institute changes it felt were needed.. 6

Under Section 890.201 of the Code of Federal Regulations,17 OPM has set forth rules

to admit and negotiate with health plans that comply with the provisions of law.

Under OPM rules, there are no mandatory government fee schedules or price controlsand no flawed formulas governing reimbursement updates for the services of doctors,hospitals, or medical professionals.

Medical professionals should not have to wrestle with literally tens of thousands of

pages of incomprehensible rules, regulations, guidelines, and related paperworkgoverning virtually every aspect of their operations. They should also be paid on the

basis of real market conditions, reflecting real consumer demand and provider supply,

rather than the current system of administrative pricing which, because it often bearslittle or no relationship to existing real market conditions, often results in taxpayers

and patients either overpaying or underpaying for medical services or benefits. Inshort, health plans and providers should be able to operate in a system governed by a

small bureaucracy and minimal regulation. The FEHBP provides a model for

designing such a system.

5Ibid.

'"The Federal Employees Health Benefits Program: Possible Strategiesfor Reform, A Report prepared by

the Congressional Research Service for the Committee on Post Office and Civil Service, U.S House ofRepresentatives, 101 st Cong., I st Sess., Conmittee Print 101-5, May 24, 1989, p. 238."Code of Federal Regulations, Title 5, Volume 2, Parts 700 to 1199, revised as of January 1, 2001, pp.410-412.

35

* The FEHBP regulatory system is a model that provides a level playing field forcompeting health plans. As noted, OPM rules focus primarily on consumerprotection, but they also enforce a level playing field for private health plans. Forexample, all competing health plans have to accept enrollment of employees andretirees without discriminating against them on such grounds as age, race, sex, pre-existing physical or mental conditions, or health status. Health plans must alsoprovide health benefits to enrollees "wherever they may be" and guarantee their rightto renew coverage.

Plans are also required to have a standard rate structure for individuals and familycoverage and to maintain statistical records for the plan covering federal employeesseparate from their other insurance business. In order to insure their ability to payclaims, health plans must have "a special reserve fund" for operations and reinvestany fund income in the fund. Health plans must also provide for continued enrollmentof persons during the contract period and ensure enrollment without a waiting periodfor covered persons.

* The FEHBP model gives enrollees the ability to act on solid information inselecting plans, as well as doctors, hospitals, and medical treatments. In the 21stcentury, information technology will accelerate and become a vehicle for increasinglysophisticated personal decision-making. As of September 2001, according to a U.S.Department of Commerce study, 143 million Americans, or more than half of theU.S. population, were using the Internet with a growth rate of roughly 2 million newInternet users per month. ' About 70 percent of Americans in the workforce duringtheir prime years, from their 20s into their 50s, use computers; and as the same studynotes, Americans who used the computers when they were younger "will likelycontinue to do so as they age." 19

Already, 35 percent of Americans are going on-line to secure health information. 20 Bythe time the baby-boom generation starts to retire, information technology will almostcertainly play an increasingly important role in decision-making among doctors andpatients alike. They should have routine access to the best possible information fromauthoritative sources on plans, benefits, treatments, and procedures. Information onquality, price, and benefits should characterize plan choice for the next generation ofMedicare patients, and that information should be provided not simply by healthplans themselves, but also by various consumer and retiree organizations, union andemployee organizations, and ethnic, fraternal, and even medical and religiousorganizations.

Historically, enrollees in the FEHBP have had regular access to clear, comparativehealth information from both government and private-sector sources. OPM annuallypublishes a Guide to FEHBP plans. This is a simple, detailed, and plain-Englishcomparison of health plans, rates, and benefits.

"tSee A Nation On-Line: How Americans Are Expanding Their Use of ihe Internet, U.S. Department of

Commerce, National Telecommunications and Information Information, Economics and StatisticsAdministration, February 2002, p. 1."Ibid., p. 14."Ibid, p. 2.

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Prominent private-sector organizations publish comparative information on healthplans. The National Association of Retired Federal Employees (NARFE) publishesFederal Health Benefits and Open Season Guide, which is oriented specifically tofederal retirees and rates plans on benefit packages. The Washington ConsumersCheckbook publishes Checkbook's Guide to Health Insurance Plansfor FederalPlansfor Federal Employees. Written in plain English, both of these guides provideexcellent comparative information on price, benefits, and service. Beyond thepublished guides, FEHBP enrollees are now getting comparative information on theInternet. As a matter of policy, OPM is accelerating the provision of on-lineinformation, particularly for retirees.

There is no reason why 2 15 century retirees, particularly the baby-boom generation,should not be able to take advantage of rapidly advancing information technology forperiodic health plan comparisons, and even more detailed comparative information onquality, service, outcomes, and the availability of evidence-based medicine amongproviders.

* The FEHBP model provides for a financially stable program. The FEHBP trustfund is unified, and its administration is comparatively simple. Both the governmentcontribution and all beneficiary premium payments are combined and deposited in theFederal Employee Health Benefits Trust Fund.

For federal retirees, OPM administers their enrollment, provides for an automaticdeduction of their portion of the premium from their monthly federal retirementchecks, adds the applicable government contribution, and deposits that money in theFEHBP trust fund. Congress appropriates projected amounts for the FEHBP trustfund for federal retirees as part of the annual Treasury and Postal Appropriationsprocess.

While the FEHBP trust fund is administered by OPM, it is formally a part of theUnited States Treasury. The Secretary of the Treasury, in consultation with OPM, hasthe legal authority to invest the assets of the trust fund in federal governmentsecurities, and interest income from these government securities is also credited to thetrust fund. During the contract year, payments to health insurance plans or carriers aremade directly from the U.S. Treasury and charged to the FEHBP trust fund. OPM'sadministrative expenses are also charged to the FEHBP trust fund.

Premium income and disbursements in the FEHBP trust fund are easily tracked. Thefund's income is routinely subject to congressional action and oversight. If, for anyreason, there is a need for a supplemental appropriation for the FEHBP trust fund,Congress can and does provide for it. In this respect, the FEHBP trust fund model issuperior as a mechanism for monitoring the solvency and ensuring the financialstability of a modernized Medicare system.

CONCLUSION

The FEHBP is 43 years old. It is older than Medicare, Medicaid, and most privateemployment-based managed care arrangements. We know a great deal about it, both itsstrengths and its weaknesses. While the program is by no means perfect, there is little

37

doubt that it is a government program with a solid record of success. This success isevident in its ability over time to deliver high-quality health care within a pluralisticframework of consumer choice and market competition.

In designing a superior program for retirees, the challenge is to match the FEHBP in itsperformance. Specifically, the challenge is to match it in the breadth of choice availableto enrollees, the flexibility of its administration, the ease with which benefits are added ormodified, and the comparative absence of bureaucracy and red tape in its operations. Inthese areas, the FEHBP provides an excellent model for designing major improvementsin the way in which we can finance and deliver medical benefits to America's seniorcitizens, particularly the first wave of the baby-boom generation set to retire in just eightyears. Thank you.

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The CHAIRwAN. Bob, thank you very much for that testimony.Now let us turn to some questions, and we will do 5-minute

rounds. As I ask a question of one of you, if any of the others ofyou wish to join in and make comment to that question, please doso.

Ms. Block, let me first start with you. If Tom Scully were to walkinto your office today and offer the current Medicare fee-for-serviceprogram for inclusion in FEHB, would it qualify?

Ms. BLOCK. I do not think it would for several reasons. For onething, as I have pointed out and as the other members of the panelhave pointed out, we have moved away from fee-for-service per seto a PPO type of arrangement, which is very different from tradi-tional Medicare. With that arrangement, we are certainly able tooffer a broader benefit package, obviously, including a prescriptiondrug benefit, in all of our plans. So there would be a huge dif-ference in terms of our floor benefit levels and what traditionalMedicare offers.

There would be such differences as well in the way the plan isadministered. We of course have nothing resembling the kind of ad-ministration that Medicare undergoes. It would not be a good fit,as far as I can see.

The CHAIRMAN. Largely because of the standard benefit featuresrequired?

Ms. BLOCK. Well, the benefit features are clearly a major dif-ference between our program and Medicare, as has been pointedout, and it extends beyond just the prescription drug benefit, al-though that clearly is a key feature of all the FEHB plans that ismissing from traditional Medicare. But the delivery system is alsoan issue. We are basically at this point in time PPO-based, we arenetwork-based, and that makes a huge difference.

The networks when they started out in the early 1980's were pri-marily discount arrangements with providers. They have become somuch more than that now, and we work very closely with the plansto ensure that they are more than just discount docs. There is alevel of plan oversight; there is a level of provider education; thereis a level of looking at and making sure that the providers in thenetwork are current on medical practices, that they are using thebest practices, that our customers are getting the right care at theright time. So there is a great deal more involved in running PPOnetworks today than just getting discounts from providers, and tra-ditional Medicare just does not do that.

The CHAIRMAN. Mr. Francis, you are nodding your head.Mr. FRANCIS. Yes, Senator, I agree 100 percent with what Abby

said. If we could somehow wave a magic wand and make Medicareparticipate in the FEHB plan-and OPM would not approve it ifthey had a choice, because it would not meet their standards inmany respects-and it were offered to Federal retirees as an op-tion-you know, you can join Blue Cross Standard or you can joinMedicare; pick one or the other-forget for the moment that theprograms have some coordination, treating them as separateplans-no one would join it. It would rank last in our ratings ofhealth plans for retirees.

The CHAIRMAN. So it would make the bottom of the list in yourbook.

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Mr. FRANCIS. It would make the bottom of the list.The CHAIRMAN. Mr. Moffit, any comment?Mr. MOFFIT. Well, I think that on the basis of the facts, there

is no debate. The FEHB system provides a superior quality ofhealth care and delivery for retirees, and that is true. I do notthink there is any question about it-including retirees who are nolonger covered by Medicare. You have access to prescription drugcoverage, you have access to coordinated care, you have access tocatastrophic coverage. You do not have this kind of bizarre incen-tive system where you have very, very high deductibles to get intothe hospital, but you have very, very low deductibles in MedicarePart B, which drive up health care costs. You do not have a situa-tion where people have to go out and buy two sets of plans in orderto make sure they cover gaps in coverage and pay two premiums.And you do not incur all the excessive administrative costs in that,and you do not have a situation where every, single major decisionabout the benefit, the treatment, or the procedure that you will getis subjected to a detailed regulatory intervention by the CMS. Youdo not have anything quite like that.

The CHAIRMAN. Then, maybe you have answered my follow-upquestion to you. OPM employs about 160 employees to manage theFEHB, compared to about 4,500 at CMS to regulate Medicare.Then, to what exactly do you attribute this very huge difference inemployment?

Mr. MOFFIT. First of all, it is not just Medicare. CMS has awe-some managerial responsibilities beyond Medicare.

The CHAIRMAN. Oh, yes.Mr. MOFFIT. It has the Medicaid responsibility, it has the State

Children's Health Insurance responsibility, it just has more thanMedicare. But in fact my argument is that actually, CMS is in amanagerial crisis largely because Congress has done two things.One, it has given CMS much too much to do, and second, Congressmicromanages the Medicare Program in particular. The most re-cent reports that have been documented by the General AccountingOffice and by independent analysts, both conservatives and lib-erals, indicate that the Medicare Program, no matter how you feelabout it, is extremely micromanaged. This, however, imposes enor-mous costs on the health care system.

It is true that the administrative costs of the Medicare Programare between one and two percent, formally, but none of those ad-ministrative costs count the costs of doctors, hospitals, clinics, andhome health care agencies complying with at least tens of thou-sands of pages of rules, regulations, guidelines, and regulatory pa-perwork. They have to do it.

Now, Senator Stabenow said she does not want to have all thisbureaucracy. Senator, I agree with you-but if you are going tohave a system where every benefit is carefully defined by the Con-gress and is going to be priced by the Congress, you are going tohave to regulate that system. You are going to have to make surethat those prices are correct and that there is going to be moni-toring of those prices to make sure that the doctors, all 800,000 ofthem, in the country are agreeing to charge those prices and arekeeping within the regulatory guidelines.

41

It seems to me, with the kind of structure you have in Medicare,you cannot avoid a massive expansion of bureaucracy and red tape.But that expansion is costing the health care system. My point, Mr.Chairman, is that every dollar that goes into the compliance withthis regulatory system on the part of doctors and hospitals andhealth clinics is a dollar that is lost to patient care in the system.We have to start to count that as well in terms of when we starttalking about the additional costs of Medicare.

The CHAIRMAN. Thank you.Let me turn to Senator Stabenow. Senator?Senator STABENOW. Thank you, Mr. Chairman.I would go back and again say that I believe there is much we

can do in terms of the bureaucracy. There is much more microman-aging that happened even after 1997, with the changes that weremade at that time, that I believe were very much micromanaging.

This has been very informative, and I appreciate the informationthat all of you have provided. When I look first at comparing Medi-care and FEHBP, in the Federal system, the prescription drug ben-efit is available in every option; isn't that correct?

Ms. BLOCK. Yes.Mr. FRANCIS. Yes.Senator STABENOW. What has been at least put forward to

date-and we have not yet put our mark on it in the Senate at thispoint-but what has been proposed by the administration is notthat. They have said that if you stay in traditional Medicare, youwould get a discount card, possibly some catastrophic help, but youwould only get full comprehensive prescription drug benefit if youwent into a private plan. So it is different than what you are sug-gesting, and I would certainly support more of a model of what youare saying, that regardless of the plan you pick, you receive com-prehensive prescription drug coverage.

This goes back, though, to the experience that my mother hadwith Medicare+Choice that was not funded appropriately, and theprivate sector dropped Medicare. This goes back to what I believeis the larger question of are we trying to upgrade Medicare in qual-ity because we want better health care, and we want prescriptiondrug coverage, and we want it to be, as you all talked about, thebest quality we can have, or are we trying to save dollars-becausethose are not necessarily the same thing.

Today in The New York Times in fact, there is a major articlethat talks about this very question and comparing private plans,the rates that are paid to doctors and hospitals and home healthproviders and so on to what is paid under Medicare, because wehave taken the approach under Medicare of saving costs by just re-ducing provider reimbursements.

I would welcome anyone's information regarding cost, because Ithink this is important. We have been given at this point-I wantto read you just a little bit from the article. There has been $400billion set aside in the budget resolution for some proposal whichin my mind does not begin, from the numbers that we are seeing,to do what you are talking about if you are really going to providethe same kind of care regardless of plan. But in The New YorkTimes today, just to quote a paragraph, "The Medicare PaymentAdvisory Commission, a nonpartisan Federal advisory panel, re-

42

cently had a study done comparing fees paid by Medicare and pri-vate health plans. Zachary Deichman, the economist who did thestudy, collected data from 33 health plans of 31 million people. Inan interview today, Mr. Deichman said he had found that privatehealth plan fees are about 15 percent higher than Medicare fees"-and then they go on to show various categories. It is 26 percenthigher for surgery fees in the private plans such as we have; radi-ology is 19 percent higher; other diagnostic services are 23 percenthigher.

So as we look at these two issues-on the one hand, those sayingthat reform is about saving dollars versus reform is about improv-ing quality and choice-how do you reconcile that?

Mr. FRANcIs. If I may comment, Senator Stabenow, that is agreat question, and there was one point in my testimony that I for-got to cover that is very important. I updated a study for you, forthis committee,that I had done a few years back comparing changein cost over time of the Medicare and FEHBP programs. It turnsout that if you go back almost 30 years, the two programs have tiedin cost containment. That is, the annual rate of growth measuredin the way I detail in my testimony has been identical over timein the two programs. Yet on the one hand, we have a Medicare Pro-gram that pays providers less, that is micromanaged, that cease-lessly seeks-the Congress every year is forced to go through legis-lative contortions to come up with some dollar savings.

Your best efforts have barely tied the efforts of Abby Block andthe system over which she presides, which painlessly obtains, iden-tical cost containment over time.

I will go beyond that. We have already talked about the benefitsare better in FEHBP. They have improved over time. Medicare'shave not.

So we have a program that has contained costs while improvingbenefits to a level that is far superior to Medicare.

Point No. 3-and this again picks up on something that Abbysaid-the managed care features in the plans in this program savelives. They are not just there to hold patients' hands. There arereasons why networks are set up, why certain kinds of reviews areundertaken.

For example, here is a benefit in this program that does not existin Medicare-large-scale case management. If you have a seriousproblem that requires, either going into a nursing home or stayingat home while you recover from open heart surgery-or go backinto the hospital-and it is going to cost the plan tens of thousandsof dollars, they can give you a benefit that is not even in their legalcontract-for example, a home health care benefit to keep you outof the hospital-saving them money and saving you the trauma ofthat hospitalization.

The point is that Medicare could never pass the quality stand-ards that the FEHBP plans pass, and OPM is working hard on im-proving those systems, working with the private accreditation bod-ies. I could go on and -on, but let me just stop there-it controlscosts better, provides better care, and provides better benefits.

Senator STABENOW. Just as a quick follow-up, are you sug-gesting, then, that it would cost no additional dollars in Medicareto have an average 15 percent increase in fees for providers and

43

increase-that it would not cost additional dollars under Medicareto get to this system?

Mr. FRANCIS. I cannot give you a guarantee. I would answer youin a slightly different way. The FEHBP uses a dynamic, competi-tive, market-driven, consumer-driven system over time, where con-sumers are always making choices-in open season, you face achoice of benefits, premium costs, out-of-pocket costs, quality of thenetwork, is your physician in it, for example, and so on-and con-sumers make those choices. Only 5 or 10 percent switch every year.But that keeps the plans honest, if you will. It keeps immensepressure on the plans to keep costs down and quality up. And overtime, there is no reason to think that that system could not out-perform Medicare in cost containment.

Senator STABENOW. I would be happy, Mr. Chairman, to followup further, but I would love to see some studies that compare peo-ple of all ages in all health conditions in one system right now thathas better payouts in all areas to a system that is covering olderpeople in the country and the disabled and compare both of thoseright now and say that somehow, for the current dollars going intoMedicare and the current very low reimbursements to our pro-viders, we could switch to that and it would not cost any more dol-lars. You are hired if we can do that.

The CHAIRMAN. Thank you.Let me ask a couple more questions before we turn to our next

panel.I think that both you, Senator, and Mr. Francis, Mr. Moffit and

Ms. Block-we have all touched on the same things in part here.While there is a cost component to this that we will debate, I donot want my seniors denied service, and yet they are being deniedservice by primary care providers today because they will not takethem because they can no longer afford to take Medicare. In part,that is our fault; it is part of that micromanagement that we doaround here. I cannot even believe that we sit here in Congressand debate the tiniest specifics of Medicare benefits, and services,but we do, and we have for 30 years. We add a few every year orwe take away a few, and then we crunch down the costs by allo-cating a certain fixed amount of resources and expect all thoseservices to comply into it.

What is unique-I think you have just said it, Mr. Francis-isthat in this dynamic, the private sector has arrived at the samecost containment success that we have in Medicare, with its hugebureaucracy and a phenomenal layout of resource and less serviceas it relates to the total care package offered-and no options.

In designing flexibility and adding the component that I thinkboth the Senator and I want, and that is prescription drugs, thequestion is how do you allow the market forces to deal with costas it relates to innovation or additional services?

I am increasingly getting-as I suspect your office is-a bit of apanicked phone call on occasion from a senior who has just beentold that his or her primary care physician is retiring, and nowthey are out shopping for one and cannot find one who will takenew Medicare patients. We are getting that limiting factor, so Iguess my question is as it relates to access through the private sys-tem versus access through Medicare and the denial of service. Is

44

there a growing disparity there, or are we simply getting physi-cians who will transfer costs over, if you will, to those who can af-ford to pay in relation to the less than comparable system thatMedicare serves?

Can you react to that, any of you?Mr. FRANcIs. One quick comment, and Abby might want to say

more-I do not want to put her on the spot. I think that centralto the FEHBP as it has evolved-this was not true 15 years ago,but it is true today-the fee-for-service plans basically have twosets of benefits-one for going to any doctor in the country-thatis the traditional fee-for-service component-and one if you use pre-ferred providers. You get a much better deal if you use preferredproviders, and preferred provider panels are huge. We are not talk-ing about little, teeny-weeny HMO groups; we are talking about 50to 60 percent of physicians typically in these plans. But that is not100 percent.

The difference is that if you go out of plan, out of the preferredpanel, you will have to pay more. Your reimbursement share willbe higher, and the physician may charge you a little more than hewould have charged if you were preferred, although you do not seethat on the preferred side.

So I do not want to claim that it is perfect for everybody-thereis no guaranteed satisfaction of all problems in the world in anyprogram. But because you have this double tier of benefits, for inand out of network, the plans are much more flexible and thechoices that consumers face are much wider.

Mr. Chairman, and in that, you are arguing or at least believethat over time-we will go back to the New York Times article thatI found fascinating this morning also-and it is a debate that wewill get into; some will argue that we are going to get great costsavings benefits, that over time, it is a factor of competition thatcreates innovation within the system and has the potential forsome cost containment-or, more than potential-it has proven tocontain costs.

I think you mentioned the premium increase in the last year ortwo-and this program has been very high-you cannot look at oneor two years. You have to look over long periods of time. My com-parisons are sort of 10-year rolling averages, because the FEHBPhad some very good years in the early nineties when Medicare wasstruggling with some very bad years. So if you were clever and youpicked the right base year in a short period, you could prove almostanything. But if you are honest about it, over time, on average, thisprogram saves money as well if not better than Medicare.

Senator STABENOW. Mr. Chairman, if I might.The CHAIRMAN. Yes, Senator.Senator STABENOW. Thank you.First, let me go back and say that we do agree that these are dif-

ferent systems in the sense of one covering people of all ages,healthy people, sick people, and so on, and that with Medicare, itis older individuals by definition who are going to need more healthcare on average, have more health concerns, and the disabled. Sothey are different systems, and as we analyze this, we need to lookat who the pool is that is being covered.

45

But I guess I would go back again and say that while I think pri-vate-public sector partnerships work, and I am very intriguedabout doing this, the idea that somehow we could do this and bringeveryone up to where government employees are without additionaldollars I think is a rather naive or foolish kind of thought.

In the beginning-and I am not criticizing a panel member; I amsaying as colleagues, as all of us-at this point, this has been ar-gued as a way to save dollars, yet I would argue that if we in-creased the fees at least in Michigan by 15 percent for every healthcare provider, we would have no problem with access, whether itis up in the Upper Peninsula or in lower Michigan, if we increasefees-if we just went to the fees that are paid by Blue Cross, wewould not have a problem right now.

So the problem has been that we have been cutting service, wehave been cutting fees, and I am very much willing to look at dif-ferent ways to gain cost savings and competition and the kinds ofthings-as long as we understand that in the end, this is a systemthat every plan has prescription drug coverage, it is a system thatpays out more than so far we have been willing to do as a Con-gress.

The first step is to stop cutting if we want to stop losing accessto care. That is the first step. Do not institute the next round of15 percent cuts to home health; do not institute the next 5 percentcut to physicians; do not institute the next round for hospitalswhile we are figuring this out, if we care in fact about not losingaccess to care, which I know we all do.

So I would like, Mr. Chairman, to see us really analyze what weare talking about in terms of the dollars that are put aside versuswhat we are talking about here in the budget, and I feel verystrongly that we have not decided that health care is importantenough right now to really make sure that this works when we puta plan in place. I go back to Medicare+Choice, where there was anoption put out there, not adequately funded, and it failed.

So we can put forward a structure, and if we are not willing tofund it, it does not matter what the structure is-it will fail. I hopethat part of this is going to be a debate about how much we arewilling to invest in health care for older Americans.

The CHAIRMAN. I thank you very much.Yes, Ms. Block?Ms. BLOCK. I would like to talk a little bit about the kinds of

things that we can do very easily in the FEHB program that theMedicare Program as currently structured cannot do.

In the past several years, we have become very aware of pro-grams that fall under the umbrella of what we call "care manage-ment"-and Walt mentioned earlier case management, which isone piece of care management; another important piece is diseasemanagement programs-because we started to believe that theyhad an enormous potential, first of all in keeping people withchronic illnesses healthy longer and also being able to avoid unnec-essary costs that come about because people were not getting theright care for chronic diseases and so ended up with very costlyhospitalizations, in the case of diabetics, amputations, blindness-consequences that can be avoided if people get the right care and

46

get it early enough and with enough continuity to ensure that theyare under treatment and under appropriate treatment all the time.

We have worked very closely with our health plans. Blue Crossand Blue Shield and the Mail Handlers Plan which is underwrittenby First Health have developed and are in the process of imple-menting and evaluating excellent care management programs thatwe think will have the dual benefit of keeping people healthierlonger and also saving money, and that is one of the fiscal offsetsthat we can arrange by working in collaboration with our privatehealth plans for the benefit of all.

So we do that very easily because we are so non-hierarchical.Our director, Kay James, has been extremely supportive of caremanagement programs. We have talked about it in our call letterfor the last couple of years. We just do that very easily. We lookat it, we say this looks like a good idea, let us move in this direc-tion, let us work with the plans, and let us see what we can imple-ment. That is the kind of flexibility we have, and I think it is bothbeneficial to people, and there are also financial benefits.

The CHAIRMAN. Thank you.Mr. FRANcIs. Just an amusing comment if I may, Mr. Chairman.

When I was at HHS, one of my main functions was as regulatoryreview czar, and I did a study once that showed that it took whatwas HCFA, now CMS, on average 4 years to issue a regulationfrom the day that the idea was thought of until the final rules wereset in place.

What Abby is talking about is night and day faster and more re-sponsive and more workable than doing this kind of thing by regu-lation and trying to nail down every dot and cross every "t," andyou get it wrong-end of speech.

The CHAIRMAN. We will let you have the last word on the panel,Mr. Moffit, and then we will move to our second panel. Go ahead.

Mr. MOFFIT. All right. I just want to say one thing. Our debatehas been constantly in terms of the current demographic frame-work. The problem is not now. The problem is the future. The prob-lem is 8 years from now. The important thing to understand is that8 years from now, we are going to have an unprecedented demandfor medical services unlike anything in human history or anythingwe have ever seen before.

The point here is-and that is why the structural issue is impor-tant-the only way that you can control cost in the current struc-ture of Medicare is ultimately to reduce reimbursement-but re-ducing reimbursement ultimately means you are going to controlcosts by reducing the supply of services, the quality and the quan-tity of services. That is not an unintended consequence of price con-trols. That is an intended consequence of price controls-to makesure that we spend less in that sector of the economy. That has gotto be understood.

The most important thing, and one argument that I hope myselfand my colleagues here have made, is that within a structure thatrelies on a market, you can have fairly ruthless control of cost onthe basis of an interaction of supply and demand, but in a systemthat is governed by price controls and central planning in effect,the only way you are ultimately going to control cost is to reducethe supply of services-and that is the problem.

47

Thank you.The CHAIRMAN. That is a very important point in the whole issue

of this debate, and we thank you very much for being with us thismorning.

Now let us turn to our second panel, and if our colleague SenatorCarper would wish to join us, we are pleased to have you with us.He is a back-bencher this morning-but rarely that.

The CHAIRMAN. Our second panel this morning will discuss asomewhat broader set of issues involving comparisons betweenMedicare and private insurance generally, looking at questions ofcomparative cost, the very issues that Senator Stabenow broughtup a few minutes ago, quality, and value.

Marilyn Moon is a Senior Health Policy Fellow at The Urban In-stitute and a distinguished expert on Medicare and health care pol-icy.

Joe Antos is currently a Scholar at the American Enterprise In-stitute but has had a long career in government work involvingboth CBO and the old HCFA.

Jeff Lemieux is a Senior Economist at The Progressive Policy In-stitute and was previously a senior staff member in the 1999 Presi-dential Medicare Commission and a CBO economist.

We look forward to your testimony, and I think your testimonyfollows well with the discussion just had with the last panel as itrelates to costs and benefits as we deal with this important policyissue and debate.

So, Ms. Moon, if you would start, please proceed.

STATEMENT OF MARILYN MOON, SENIOR HEALTH POLICYFELLOW, THE URBAN INSTITUTE, WASHINGTON, DC

Ms. MOON. Thank you, Mr. Chairman.It is my pleasure to be here today, and I appreciate the invita-

tion.I am going to be the skeptic on the panel today and argue essen-

tially that private plans are not a magic bullet for Medicare, andthat there are a lot of pros and cons that need to be assessed inanalyzing whether or not we should rely on private plans and towhat extent.

I do not think anyone any longer is saying there should be noparticipation of private plans, nor is anyone saying there should beno traditional Medicare-or at least I hope that is not the case. Ithink it is better to think about this issue in terms of the right bal-ance between public and private shares.

But it is important to ask whether the benefits from greater par-ticipation of private plans be worth the additional problems andcosts that could arise in some cases.

There are likely to be big negative impacts from a plan that re-lies extensively on private plans, particularly if it does damage tothe traditional Medicare Program, in return for little positive re-ward. First of all, it is important, as Senator Stabenow did, to sep-arate out the issue of the structure of the program from the bene-fits covered by the program. No one is going to argue that Medicarehas a wonderful benefit package and therefore that we should stickwith traditional Medicare because of its stunning benefit package.But adding additional benefits is not necessarily inherently some-

48

thing that can only be done in a private plan structure. In fact,People have estimated that it would cost in the range of $850 to$900 billion to add prescription drugs of the type that are availableto Federal employees in a Medicare Program, and I believe thatwould be true whether we were talking about private plans or basicMedicare plans.

The simple fact of the matter is that drugs are expensive, seniorsand persons with disabilities use extensive numbers of drugs, andif we make them more available to them, we will see costs go upover time.

I also argue in my testimony that Medicare rates of growth ona per capita basis are less than the private sector, and that claimhas gotten me into some hot water. We agree that the data we useare not very good and we would like to have better data, but it sim-ply does not exist. The additional dimensions that I have seen peo-ple add to tweak our study, are unconvincing. I still believe thatour work indicates that Medicare does a little better than the pri-vate insurance sector over a long period of time. Over 30 years, ona cumulative basis, the difference amounts to about 19 percent.

Actually, looking at Mr. Francis' testimony, I think that he andI are actually pretty much on the same page. He argues that thereis a 1-percentage point difference in Medicare over a long period oftime, on an annual basis. That actually translates close to the 19percent, because the 1 percentage point is on a basis of 5 percentversus 6 percent. That is a big difference over a very long periodof time. I would like to have that compounding difference in theMedicare Program, for example, that you would get.

I think our study is consistent with the information today in TheNew York Times.

The other question I think is a relevant one to ask, and that iswhether competition adds to this in terms of private plans com-peting, and that is an important issue and. question. I will let oth-ers talk about the many advantages to competition, and I will men-tion just a couple of potential problems.

First is the issue of risk selection. This is a serious issue thatneeds to be taken into account. It cannot be simply said that therewill be risk adjustments. Let us assume there will be a risk ad-juster. Over 20 years of study and effort have gone into this, andwe have not come very far as yet. Risk selection is going to be anissue, particularly to the extent to which benefits vary substan-tially. Younger, healthier folks will quite naturally be attracted toplans that have benefits that they like and not home health cov-erage, for example, which will appeal to a sicker population.

I do not see, again, very much advantage here from that perspec-tive. In addition, the complexity that arises from competition issomething that should not be understated. I would be happy tocompare my experiences with choice and a PPO that pays essen-tially half of what Medicare pays my physician when I go to her.I will be better off when I go on to traditional Medicare from thePPO that I am in, Care First, and I would also be happy to discusssome of the other complexities and problems with that plan.

What we need to keep in place in Medicare is the universalityand redistribution that occurs in the program that is an essentialpart of social insurance. The pooling of risks, also needs to be

49

maintained or a way found to adjust for the loss of risk poolingwhen relying on private plans. Finally, an important role for gov-ernment in protecting the program over time also needs to be re-tained.

I would like to make two final comments. One is that the admin-istrative costs of Medicare are often misunderstood and misinter-preted, because remember-Medicare is running an insurance pro-gram. If anything, it needs more dollars to run it well. Adding an-other layer of private plans will add to administrative costs.

I am all in favor of many changes in the traditional program, notthe least of which would be coordination of care. But I see very lit-tle innovation in a lot of the private plans out there today to sug-gest they are already better than traditional Medicare.

The CHAIRMAN. Ms. Moon, thank you very much.[The prepared statement of Ms. Moon follows:]

50

MEDICARE AND PRIVATE PLANS:

SEPARATING FACT FROM FICTION

Marilyn Moon

Senior Fellow

The Urban Institute

Testimony for

The Senate Committee on Aging

May 6,2003

The material presented in this testimony represents the opinions of the author and not of the

Urban Institute, its officers or funders.

51

I am pleased to be here today to testify about the role that greater reliance competition

among private plans to serve Medicare beneficiaries should play. I will argue that a number of

issues need to be carefully weighed before moving in this direction. Market forces do not

represent the magic bullet that will solve all of Medicare's problems. Rather, the issue is to what

extent they can help at the margins. Difficult challenges arise in deciding how to reform

Medicare to meet future demands that at aging population and rising health care costs inevitably

will place on the system. Costs to society for the health care of older and disabled Americans

will rise over time, both in dollars and as a share of our economy. This will put pressure both on

financing issues and on other changes that will help the program move into the future.

Technological advances that raise the costs of care are the primary reason for higher costs

over time, and this phenomenon is occurring system wide, not just in Medicare. Further, a

beneficiary population that is growing now because of increased life expectancy and will be

exacerbated in the future by the retirement of the baby boom raises issues well beyond any

restructuring options.

Nonetheless, much of the debate on Medicare's future has focused on broad restructuring

proposals. This restructuring would rely upon contracting with private insurance plans, which

would compete for enrollees. Claims for savings from options that shift Medicare more to a

system of private insurance usually rest on two basic arguments: first, it is commonly claimed

that the private sector is more efficient than Medicare, and second, that competition among plans

will generate more price sensitivity on the part of beneficiaries and plans alike. The federal

government would subsidize a share of the costs of an average plan, leaving beneficiaries to pay

52

the remainder. More expensive plans would require beneficiaries to pay higher premiums. The

goal of such an approach is to make both plans and beneficiaries sensitive to the costs of care,

leading to greater efficiency.

It is most appropriate to think about reform in terms of a continuum of options that vary

in their reliance on private insurance. Few advocate a fully private approach with little oversight;

similarly, few advocate moving back to 1965 Medicare with its unfettered fee-for-service and

absence of any private plan options. In between, however, are many possible options and

variations. And although the differences may seem technical or obscure, many of these "details"

matter a great deal in terms of how the program will change over time and how well beneficiaries

will be protected.

A particularly crucial issue is how the traditional Medicare program is treated. Under the

current Medicare + Choice arrangement, beneficiaries are automatically enrolled in traditional

Medicare unless they choose to go into a private plan. Alternatively, traditional Medicare could

become just one of many plans that beneficiaries choose among -- but likely paying a

substantially higher premium if they choose to do so.

Restructuring could profoundly affect Medicare's future. In particular, the traditional

Medicare program could be priced beyond the means of most beneficiaries, leaving only private

plan options from which to choose. Further, if-plans began to sort into two groups of higher cost

and lower cost plans, beneficiaries would likely be segregated in plans on the basis of their ability

to afford care. This would be quite different than today where at least the basic program treats all

beneficiaries alike.

53

MEDICARE VS. THE PRIVATE SECTOR

Looking back over the period from 1970 to 2000, Medicare's cost-containment

performance has been better than that of private insurance. Starting in the 1970s, Medicare and

private insurance plans initially grew very much in tandem, showing few discernible differences

(See Figure 1). By the 1980s, per capita spending had more than doubled in both sectors for

comparable services. But Medicare became more cost-conscious than private health insurance in

the 1980s, and cost containment efforts, particularly through hospital payment reforms, began to

pay off. From about 1984 through 1988, Medicare's per capita costs grew much more slowly

than those in the private sector. Thus, its base relative to the private sector contracted and a gap

in the two growth lines shown in Figure 1 opened up.

This gap in overall growth in Medicare's favor stayed relatively constant until the mid

1990s when private insurers began to take seriously the rising costs of health insurance. At that

time, growth in the cost of private insurance moderated in a fashion similar to Medicare's slower

growth in the 1980s. Thus, it can be argued that the private sector was playing "catch up" to

Medicare in achieving cost containment. Private insurance narrowed the difference with

Medicare in the 1990s, but as of 2000, there was still a considerable way for the private sector to

go before its cost growth would match Medicare's achievement of lower overall growth.

Criticism of the study that Cristina Boccuti and I recently completed that resulted in

Figure I has focused on the crudeness of the data. To be sure, we would like to control for many

additional factors, but by eliminating from the chart services such as prescription drugs that are

more fully covered by the private sector than Medicare, we have controlled for some of the

54

changes in coverage over time. The data we used cannot be divided up to look at how out of

pocket costs have changed over time, because it is not possible to distinguish, for example, the

contributions made by Medicare, Medicaid and the private sector.

It should not be surprising that the trends in per capita rates over time are similar between

Medicare and private sector spending, because all health care spending shares technological

change and improvement as a major factor driving high rates of expenditure growth. To date,

most of the cost savings generated by all payers of care has come from slowing growth in the

prices paid for services and making only preliminary inroads in reducing the use of services or

addressing the issue of technology.

Medicare has made some innovative strides towards affecting use of care, particularly

through its emphasis on prospective payment, first in hospitals and now in skilled nursing

facilities and home health care. Taking a different route, the private sector route relied on

capitated managed care organizations (MCOs) to slow growth in use of services in the 1990s, but

a strong backlash against MCOs attests to the problems they have had in addressing this issue.

WILL RELYING ON PRIVATE PLANS INHERENTLY LEAD TO SAVINGS FOR

MEDICARE?

Some supporters of a private approach seem to assume that private plans inherently offer

advantages that traditional Medicare cannot achieve. But there is no magic bullet to holding the

line on the growth in health care spending. Per capita spending rises because of the growth in

use of services, higher prices, or a combination of the two. Medicare's price clout is well known

55

and documented.

So what about use of services? Studies of managed care have concluded that most of

them saved money by obtaining price discounts for services and not by changing the practice of

health care. Reining in use of services represents a major challenge for private insurance as well

as Medicare in the future, and it is not clear whether the public or private sector is better

equipped to do this. The newest type of plans suggested as an improvement for Medicare

beneficiaries, preferred provider organizations (PPOs), generally obtain their savings by paying

very little for any patient who goes outside the network to get care. Thus, their strategy is often

one of cost shifting onto beneficiaries. This may hold down PPO premiums, but from society's

standpoint, does little to help with reducing health care costs.

Private insurers are interested in satisfying their own customers and generating profits for

stockholders. When the financial incentives they face are very broad (such as receiving capitated

payments), private insurers respond as good business entities should. They seek the easiest ways

of holding down costs in the provision of services. This indeed is what competition is all about.

Cream skimming of the market serves these goals very well: Medicare overpays, and plans can

both make the healthier beneficiaries they enroll very satisfied while making good profits. The

problem is that this response is not good for limiting overall costs to either the federal

government or to society as a whole. Thus, care needs to be taken to use the market when we

understand and approve of the direction that competition will take health care delivery.

In addition, private insurers will almost surely have higher administrative overhead costs

than does Medicare. Insurers need to advertise and promote their plans. They would face a

56

smaller risk pool that may require them to make more conservative decisions regarding reserves

and other protections against losses over time. These plans expect to return a profit to

shareholders. All of these factors cumulate and work against private companies performing

better than Medicare.

Finally, it is important to note that few private insurance companies escape problems of

complexity and bureaucracy. Many patients, both young and old, find the requirements of their

plans to obtain approval before getting some services, to determine which doctors and hospitals

are in network and which are not, to understand the bills when they come due months later, and

to use the appeals process to be cumbersome, complex and overly bureaucratic. Thus, problems

with the complexity of our current health care system are by no means.inherent only to

government. So examrining reform from the context of Medicare beneficiaries should consider

whether more reliance on private plans will only complicate and confuse beneficiaries further.

An assumption is often made that using private plans to provide services will ease the

government's oversight burdens, but at what expense to beneficiaries?

USING COMPETITION TO GENERATE SAVINGS

Reform options such as the premium support approach seek savings not only by relying

on private plans but also on competition among those plans. Often this includes allowing the

premiums paid by beneficiaries to vary such that those choosing higher cost plans pay

substantially higher premiums. The theory is that beneficiaries will become more price

conscious and choose lower cost plans. This in turn will reward those private insurers able to

57

hold down costs. And there is some evidence from the federal employees system and the Calpers

system in California that this has disciplined the insurance market to some degree in the 1990s.

But the experiences in the last few years lend considerable doubt to that enthusiasm.

Studies that have focused on retirees, moreover, show much less sensitivity to price

differences among older Americans. Older persons may be less willing to change doctors and

learn new insurance rules in order to save a few dollars each month. Thus, what is not known is

how well this will work for Medicare beneficiaries.

For example, for a premium support model to work, at least some beneficiaries must be

willing to shift plans each year (and to change providers and learn new rules) in order to reward

the more efficient plans. Without that shifting, savings will not occur. In addition, there is the

question of how private insurers will respond. (If new enrollees go into such plans each year,

some savings will be achieved, but these are the least costly beneficiaries, and may lead to further

problems as discussed below.) Will they seek to improve service or instead focus on marketing

and other techniques to attract a desirable, healthy patient base? It simply isnt known if the

competition will really do what it is supposed to do. In fact, undesirable outcomes may be as

common as desirable ones.

New approaches to the delivery of health care under Medicare may generate a whole new

set of problems, including problems in areas where Medicare is now working well. For example,

shifting across plans is not necessarily good for patients; it is not only disruptive, it can raise

costs of care. Studies have shown that having one physician over a long period of time reduces

costs of care. And if it is only the healthier beneficiaries who choose to switch plans, the sickest

58

and most vulnerable beneficiaries may end up being concentrated in plans that become

increasingly expensive over time. The case of retirees left in the federal employees high-option

Blue Cross plan and in a study of retirees in California suggest that even when plans become very

expensive, beneficiaries may be fearful of switching and end up substantially disadvantaged.

Private plans should not be expected to meet larger social goals such as making sure that

the sickest beneficiaries get high quality care if the financial incentives do not lead to such

behavior. To the extent that such goals remain important, reforms in Medicare win have to

incorporate additional protections to balance these concerns as described below.

WHAT IT IS CRUCIAL TO RETAIN FROM MEDICARE

The reason to "save" Medicare is to retain for future generations the qualities of the

program that are valued by Americans and that have served them well over the past 37 years.

This means that any reform proposal ought to be judged on principles that go well beyond the

savings that they might generate for the federal government.

I stress three crucial principles that are integrally related to Medicare's role as a social

insurance program:

* The universal nature of the program and its consequent redistributive function.

* The pooling of risks that Medicare has achieved to share the burdens across sick and

healthy.

* The role of government in protecting the rights of beneficiaries-often referred to as its

entitlement nature.

59

Although there are clearly other goals for and contributions of Medicare, these three are part of

its essential core. Traditional Medicare, designed as a social insurance program, has done well in

meeting these goals. What about options relying more on the private sector?

Universality and Redistribution

An essential characteristic of social insurance that Americans have long accepted is the

sense that once the criterion for eligibility of contributing to the program has been met, that

benefits will be available to all beneficiaries. One of Medicare's great strengths has been

providing much improved access to health care. Before Medicare's passage, many elderly

persons could not afford insurance, and others who could not obtain it were denied coverage as

poor risks. That changed in 1966 and had a profound impact on the lives of millions of seniors.

The desegregation of many hospitals occurred under Medicare's watch. And although there is

substantial variation in the ability of beneficiaries to supplement Medicare's basic benefits, basic

care is available to all who carry a Medicare card. Hospitals, physicians, and other providers

largely accept the card without question.

Once on Medicare, enrollees no longer have to fear that illness or high medical expenses

could lead to the loss of coverage-a problem that still happens too often in the private sector.

This assurance is an extremely important benefit to many older Americans and persons with

disabilities. Developing a major health problem is not grounds for losing the card; in fact, in the

case of the disabled, it is grounds for coverage. This is vastly different than the philosophy of the

private sector towards health coverage. Even though many private insurers are willing and able

60

to care for Medicare patients, the easiest way to stay in business as an insurer is to seek out the

healthy and avoid the sick. And in a market system, once that becomes the dominant approach,

even insurers who would like to treat sicker patients are penalized by the market if they do so.

This can clearly be seen in the poor performance of the individual health insurance market in

meeting the needs of persons in their early 60s.

Will reforms that lead to a greater reliance on the market still retain the emphasis on

equal access to care and plans? For example, differential premiums could undennine some of the

redistributive nature of the program that assures even low-income beneficiaries access to high

quality care and responsive providers. Support for a market approach that moves away from a

'one-size-fits-all" approach is a prescription for risk selection problems.

The Pooling Of Risks

One of Medicare's important features is the achievement of a pooling of risks among the

healthy and sick covered by the program. Even among the oldest of beneficiaries, there is a

broad continuum across individuals' needs for care. Although some of this distribution is totally

unpredictable (because even people who have historically had few health problems can be

stricken with catastrophic health expenses), a large portion of seniors and disabled persons have

chronic problems known to be costly to treat. If these individuals can be identified and

segregated, the costs of their care can expand beyond the ability of even well-off individuals to

pay over time.

A major impetus for Medicare was the need to protect the most vulnerable. That's why

61

the program focused exclusively on the old in 1965 and then added the disabled in 1972. About

one in every three Medicare beneficiaries has severe mental or physical health problems. In

contrast, the healthy and relatively well-off (with incomes over $32,000 per year for singles and

$40,000 per year for couples) make up less than 10 percent of the Medicare population.

Consequently, anything that puts the sickest at greater risk relative to the healthy is out of sync

with this basic tenet of Medicare. A key test of any reform should be who it best serves.

If the advantages of one large risk pool (such as the traditional Medicare program) are

eliminated, other means will have to be found to make sure that insurers cannot find ways to

serve only the healthy population. Although this very difficult challenge has been studied

extensively; as yet no satisfactory risk adjustor has been developed. What has been developed to

a finer degree, however, are marketing tools and mechanisms to select risks. High-quality plans

that attract people with extensive health care needs are likely to be more expensive than plans

that focus on serving the relatively healthy. If risk adjustors are never powerful enough to

eliminate these distinctions and level the playing field, then those with health problems, who also

disproportionately have lower incomes, would have to pay the highest prices under many reform

schemes.

The Role of Government

Related to the two above principles is the role that government has played in protecting

beneficiaries. In traditional Medicare, this has meant having rules that apply consistently to

individuals and assure that everyone in the program access to care. It has sometimes fallen short

62

in terms of the variations that occur around the country in benefits, in part because of

interpretation of coverage decisions but also because of differences in the practice of medicine.

For example, rates of hospitalization, frequency of operations such as hysterectomies, and access

to new tests and procedures vary widely by residence, race and other characteristics. But in

general, Medicare has to meet substantial standards and accountability that protect its

beneficiaries.

If the day-to-day provision of care is left to the oversight of private insurers, what will be

the impact on beneficiaries? It is not clear whether the government will be able to provide

sufficient oversight to protect beneficiaries and assure them of access to high-quality care. If an

independent board - which is part of many restructuring proposals-is established to negotiate

with plans and oversee their performance, to whom will it be accountable? Further, what

provisions will be in place to step in when plans fail to meet requirements or who leave an area

abruptly? What recourse will patients have when they are denied care? The need for this

oversight will likely add to administrative costs; if not, beneficiaries will suffer.

ASSESSING THE PROMISED ADVANTAGES OF PRIVATE SECTOR APPROACHES

A number of advantages in addition to holding the line on costs are also often put forth to

generate support for this type of approach. A private approach has the potential to reduce the

role in government of "micromanaging" health care, often expressed as no more price fixing by

government and greater flexibility for innovation and change in coverage of benefits. But even

more frequently, this approach is emphasized as a means for moving away from a 'one size fits

63

all" approach to insurance. In practice, however, some of these claims are likely to interfere with

the functioning of effective competition aimed at holding down the costs of care. Tradeoffs will

undoubtedly need to be made.

Choice

While choice and avoidance of uniformity is an appealing promise, it is important to

examine exactly what that means. Many people have made the point that most beneficiaries want

choice of providers of care-doctors and hospitals. They care much less about whether it is

Aetna or Cigna that provides the insurance. (Actually, that may turn out to be quite short-sighted

if plans vary in terms of the details of operations, such as how much they will pay for services

when someone goes out of network. But those considerations are hard to build into a choice

model since even aggressive consumers find it difficult to obtain such information.)

But the appeal for choice of plan is usually made on the argument that people will be able

to get only the coverage they want and need, even if they have to pay a little more. The difficulty

is that without standardization of the most important benefits, such choice will lead to risk

selection. Young healthy 65 year olds will pass on home health coverage, for example, in

exchange for other benefits or a lower premium. But until risk adjusters get much better (if

ever), standardization is important. Moreover, to get plans to compete on price, consumers must

be able to compare plans-another strong argument for standardization. It is not possible to

realistically expect both variation in options and health competition.

64

Flexibility, Innovation and Oversight

One of the advantages touted for private plans is their ability to be flexible and even

arbitrary in making decisions. This allows private insurers to respond more quickly than a large

government program can and to intervene where insurers believe too much care is being

delivered. But what looks like cost-effectiveness activities from an insurer's perspective may be

seen by a beneficiary as the loss of potentially essential care. Which is more alarming: too much

care or care denied that cannot be corrected later? Some of the "inefficiencies" in the health care

system may be viewed as a reasonable response to uncertainty when the costs of doing too little

can be very high indeed. This arbitrariness also means that providers can be dropped from a plan

with little notice, potentially adding to disruptions for beneficiaries.

The need for strong government oversight will not go away under a private plan approach

unless there are to be few beneficiary protections. Many insurers do not have a good track record

in this area, for example. Patient problems and complaints under the Medicare+Choice option

underscore the need to offer appeals rights, oversight and sometimes direct intervention in order

to protect beneficiaries. For example, at present when plans are found to be inappropriately

denying care to beneficiaries, the corrections are done on a case-by-case basis even after the same

plan in the same area has been told multiple times to cover a particular service. If private plans

are to be even more widespread, this will require a great deal of attention and effort.

Considerable investment in information and education would be needed-spending that

goes well beyond what Congress has been willing to commit thus far. Information about plans

should not be left solely to the responsibility of the plans themselves.

65

Unfortunately, there are too few examples of truly innovative new techniques,

organizational strategies or other contributions from private plan competition. Many managed

care plans, for example, have relied on price discounts and do not even have the data and

administrative mechanisms to attempt any care coordination. And preferred provider

organizations-the newest private form to be hailed as an improvement-rely not only on price

discounts but on passing off very high costs to beneficiaries who choose to go out of network for

their care. Here the misconception is that you can see any care provider you wish. That's true

for those with substantial resources but not for the vast majority of Medicare beneficiaries who

have only modest incomes.

If innovation is a major reason for relying on private plans, it may make most sense to

provide incentives for plans to specialize and take on those with high risks or particular

conditions. This is where innovation is needed and where care coordination potentially offers the

greatest payoffs.

Avoiding Price Setting

Moving away from traditional Medicare will not eliminate the issue of administered

prices in health care. There is no free market where doctors and plans negotiate openly on rates.

In fact, many private plans use at least some aspect of Medicare payment systems in setting their

rates. In a world of many private insurers, the likely result is hundreds of administered prices

being set for each service by each plan.

In an industry like health care where there are many examples of "market failure"

66

(because of concentrated power, lack of good information and knowledge, product

differentiation), the workings of supply and demand can lead to perverse results. For example,

competing hospitals in a given area result in over-capacity as each hospital tries to have all the

latest equipment to attract doctors and patients. As already mentioned, plans will tend to

compete to attract healthy patients rather than to develop the best management and care

coordination protocols. And yes, price setting is and will continue to be a part of the private

insurance world as well as within Medicare.

CHANGES TO IMPROVE MEDICARE

Making changes to Medicare that can improve its viability both in terms of its costs and

in how well it serves older and disabled beneficiaries should certainly be pursued. Further, it

makes little sense to look for a solution that takes policy makers permanently out of Medicare's

future. The flux and complexity of our healthcare system will necessitate continuing attention to

this program. At present a number of areas in Medicare need attention.

What are the tradeoffs from increasingly relying on private plans to serve Medicare

beneficiaries? The modest gains in lower costs that are likely to come from some increased

competition and from the flexibility that the private sector enjoys could be more than offset by

the loss of social insurance protection. The effort necessary to create in a private plan

environment all the protections needed to compensate for moving away from traditional

Medicare will be very challenging and cannot promise success. For example, even after six

years, many of the provisions in the Balanced Budget Act of 1997 that would be essential in any

67

further moves to emphasize private insurance-generating new ways of paying private plans,

improving risk adjustment, and developing information for beneficiaries, for example-still need

a lot of work.

In addition, it is not clear that there is a full appreciation by policymakers or the public at

large of all the consequences of a competitive market. Choice among competing plans and the

discipline that such competition can bring to prices and innovation are often stressed as potential

advantages of relying on private plans for serving the Medicare population. But if there is to be

choice and competition, some plans will not do well in a particular market, and as a result they

will leave. In fact, if no plans ever left, that would likely be a sign that competition was not

working well. But plan withdrawals will result in disruptions and complaints by beneficiaries-

much like those that have occurred with the withdrawals from Medicare+Choice. Beneficiaries

must then find another private plan or return to traditional Medicare. They may have to choose

new doctors and learn new rules. This situation has led to politically charged discussions about

payment levels in the program even though that is only one of many factors that may cause plans

to withdraw. Thus, not only will beneficiaries be unhappy, but there may be strong political

pressure to keep federal payments higher than a well functioning market would require.

What I would prefer to see instead is emphasis on improvements in both the private plan

options and the traditional Medicare program, basically retaining the current structure in which

traditional Medicare is the primary option. Rather than focusing on restructuring Medicare to

emphasize private insurance, I would place the emphasis on innovations necessary for

improvements in health care delivery regardless of setting.

68

Critics of Medicare rightly point out that the inadequacy of its benefit package has led to

the development of a variety of supplemental insurance arrangements which in turn create an

inefficient system in which most beneficiaries rely on two sources of insurance to meet their

needs. It is sometimes argued that improvements in coverage can only occur in combination with

structural reform. And some advocates of a private approach to insurance go further, suggesting

that the structural reform itself will naturally produce such benefit improvements. This implicitly

holds the debate on improved benefits hostage to accepting other unrelated changes. That logic

actually should run in the other direction. It is not reasonable to expect any number of other

changes to work without first offering a more comprehensive benefit package for Medicare. In

that way, payments made to private plans can improve, allowing them to better coordinate care.

And the fee for service system will also be able to change in ways that might encourage better

care delivery. For example, it is not reasonable to ask patients to participate in a program to

reduce hypertension (which can save costs over the long run) without covering the prescription

drugs that are likely to be an essential part of that effort. In addition, a better benefit package will

also allow at least some beneficiaries to forego the purchase of inefficient private supplemental

insurance. That itself should be a goal of reform.

In addition, better norms and standards of care are needed if we are to provide quality of

care protections to all Americans. Investment in outcomes research, disease management and

other techniques that could lead to improvements in treatment of patients will require a

substantial public commitment. This cannot be done as well in a proprietary, for-profit

environment where dissemination of new ways of coordinating care may not be shared.

69

Private plans can play an important role and may develop some innovations on their own,

but in much the same way that we view basic research on medicine as requiring a public

component, innovations in health delivery also need such support. Further, innovations in

treatment and coordination of care should focus on those with substantial health problems --

exactly the population that many private plans seek to avoid. Some private plans might be

willing to specialize in individuals with specific needs, but this is not going to happen if the

environment is one emphasizing price competition and with barely adequate risk adjustors.

Innovative plans would likely suffer in that environment. This is where I recommend work to

enhance the effectiveness of private plans. Further, Finally, the default plan--where those who do

not or cannot choose or who find a hostile environment in the world of competition--must, at

least for the time being, be traditional Medicare. Thus, there needs to be a strong commitment to

maintaining a traditional Medicare program while seeking to define the appropriate role for

alternative options.

A good area to begin improvements in knowledge about the effectiveness of medical care

would be with prescription drugs. Realistically, any prescription drug benefit will require efforts

to hold down costs over time. Part of that effort needs to be based on evidence of the

comparative effectiveness of various drugs, for example. Establishing rules for coverage of

drugs should reflect good medical evidence and not just on which manufacturer offers the best

discounts. Undertaking these studies and evaluations represents a public good and needs to be

funded on that basis.

Within the fee-for-service environment, it would be helpful to energize both patients and

70

physicians in helping to coordinate care. Patients need information and support as well as

incentives to become involved. Many caring physicians, who have often resented the low pay in

fee for service and the lack of control in managed care, would likely welcome the ability to spend

more time with their patients. One simple way to do this would be to give beneficiaries a

certificate that spells out the care consultation benefits to which they are entitled and allow them

to designate a physician who will provide those services. In that way, both the patient and the

physician (who would get an additional payment for the annual or biannual services) would know

what they are expected to provide and could likely reduce confusion and unnecessary duplication

of services that go on in a fee for service environment. This change should be just one of many

in seeking to improve care coordination.

Additional flexibility to CMS to manage and develop payment initiatives aimed at using

competition where appropriate also could result in long term cost savings and serve patients well.

In the areas of durable medical equipment and perhaps even some testing and laboratory

services, contracting could be used to obtain favorable prices.

These are only a few examples of changes, none of which promise to be the magic bullet,

but which could aid the Medicare program over time.

71

Figure 1

Cumulative Growth in Per Enrollee Paymentsfor Comparable Services,

Medicare and Private Insurers, 1970-2000*

1500

.! 1000

500 -

04 I I . . , ~ . . . . .

Year

I Includes hospital care, physician and cdinical services, durable medical equipment, and other professional services.Does not include outpatient prescription drugs, home health, and skilled nursing facility services.Source: C. Boccuti and M. Moon, 'Companng Medicare and Private Insurers: Growth Rates in Spending Over ThreeDecades,' Healsth Affairs 22 (MarclIApril 2003): 230-37. Analysis of National Heasth Expenditures data from CMS.

Private Insurers

A'

if,

I,

I e,

I MedicareIt

if,

Brain

72

The CHAIRMAN. Now let us turn to Joe Antos, who is currentlya scholar at the American Enterprise Institute.

Thank you, Joe.

STATEMENT OF JOSEPH R. ANTOS, WILSON H. TAYLORSCHOLAR IN HEALTH CARE AND RETIREMENT POLICY,AMERICAN ENTERPRISE INSTITUTE, WASHINGTON, DCMr. ANros. Thank you, Mr. Chairman and members of the com-

mittee.As I think the first panel pointed out quite well, the Medicare

Program faces unprecedented challenges, challenges that simplycannot be avoided, and I think the first panel was correct inobserving that the Federal Employees Health Benefits Program isa very, very capable program that is an excellent model for theMedicare Program.

However, as we know, people have raised concerns about wheth-er competitive market reform would actually work in Medicare, andI want to address four of those concerns.

First, on the assertion that Medicare controls costs better thanthe private sector, it is true-I looked at Marilyn Moon's paper,and I am one of the people she was referring to, no doubt-it istrue that, measured the way Marilyn measures it, Medicare's costsdid grow somewhat less rapidly than private insurance.

However, let us keep in mind that over the last three decades,the nature of private coverage has changed dramatically. Privateinsurance has grown and now covers substantially more of the costof services than it did in 1970. I am not talking now about addingbenefits. I am talking about how much of your cost for a given serv-ice is covered by insurance.

So we need to be careful when we do our comparison shopping.Private insurance has become a bigger benefit in that sense, inthat fair sense, and Medicare has not. It is not surprising that thelarger product is more expensive. The big box of Rice Krispies inthe supermarket costs you $3.69-I imagine; I have not been to thesupermarket lately-while the regular-size box costs $2.99. The bigbox costs more, but the cost per ounce of cereal is lower if you buythe big box. For a fixed level of financial protection, private insur-ance costs may have grown less rapidly than Medicare.

You can look at other programs. You can look at the Federal Em-ployees Health Benefits Program. You can look at the CaliforniaPublic Employees' Retirement System. The Medicare Payment Ad-visory Commission looked at those two programs, and what didthey find? They found, according to their numbers, that FEHBP'scosts grew slightly faster than Medicare's over the past 10 years;CalPERS' growth was somewhat lower than Medicare-again, noclear win for Medicare.

It is unreasonable to think that Medicare's administrative pric-ing could ultimately control spending better than a competitivemarket situation. Price controls have typically caused providers tofind ways to deliver more services. We can talk about that morelater. Tighter controls that also restrict the use of services couldprevent that, but such restrictions would have adverse con-sequences for the health of beneficiaries, consequences that I do notthink anybody would countenance.

73

The second criticism-Medicare beneficiaries would be forced tochange doctors. It is not true under an FEHB-style reform, anyway.Beneficiaries in fee-for-service Medicare can select almost any pro-vider in the country. They could have that same ability to chooseproviders under an FEHB-style reform through preferred providerorganizations, for example, organizations that allow beneficiaries togo outside the panel of providers.

Of course, the Federal Employees Health Benefits Program offersa wide range of choices. You would expect the Medicare Programto do the same thing, including, I think, HMOs and the traditionalfee-for-service plan for those who want to make those choices.

I think the argument is about giving people the option-not forc-ing them to do something that they do not want to do.

Now, it is true, as Marilyn says, that PPOs charge more if thebeneficiary goes to an out-of-network provider. I am in Blue CrossStandard Option FEHB-I am still in the program-and that re-quires that I pay $15 for a standard office visit if I stay in networkor 25 percent of the charge if I go out. That can add up to a lotof money if I got all of my health care out of network.

What should a Medicare beneficiary do about this situation?Well, that beneficiary would do what millions of Federal employeesdo every year-look in the book, look for the plans that includeyour doctors in the network.

Let us not forget that the flexibility that Medicare brings comesat a considerable cost. There are gaps in coverage, complicated andinequitable cost-sharing structures, and an exposure of bene-ficiaries to potentially unlimited financial risk. Nearly everyonewants different benefits than the traditional program offers. Nearlyeveryone buys some kind of supplemental coverage, and many paya high price to do so. In the year 2000, for example, about 10 mil-lion people bought Medigap policies with a premium averaging$1,700.

My third point is Marilyn's point as well about risk selection.The concern is that private plans might not accept sicker bene-ficiaries. I think that is a concern. When we implement a choice-based system, we absolutely must be vigilant on this point. I shareher concern.

It is comforting that the FEHB Program does not appear to haveany significant risk selection problem. It is related to the design ofthat program; we could learn some lessons there.

The fourth criticism-competition cannot work in Medicare. Aswe all know, the experience with Medicare+Choice has been verysobering. Over the past 5 years, nearly 200 plans have dropped outof the program. Is that proof that competition cannot work? Well,it is proof that the plans cannot operate under Medicare+Choice,as Senator Stabenow pointed out. Plans will not be able to competein Medicare unless we change the government's approach to man-aging the program.

Medicare+Choice did not break away from Medicare's history oftop-down price-setting and complex regulations. The program is ad-ministratively inflexible; the payments were unrealistically low anddid not reflect conditions in the local markets that you know aboutvery well. It is not surprising that plans dropped out.

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Let me conclude. Congress has an opportunity to help Medicarefulfill its promise to millions of seniors and people with disabilities.We can build on Medicare's successes, but we need not repeat itsmistakes. The program must expand to cover prescription drugs,preventive benefits, and protection against uncapped medical costs.The program must be made financially sustainable if the taxpayersof today are to receive their Medicare benefits tomorrow.

I think the Federal Employees Health Benefits Program is agreat place to start, but we cannot just stop there. We need to tai-lor it to the needs of the Medicare Program. I believe that all Medi-care beneficiaries should be given solid drug benefits, but weshould not make it a one-size-fits-all benefit. I believe that Medi-care beneficiaries should have the choice to stay with the tradi-tional program if they choose to do so.

There are certainly risks in attempting to reform a program asimportant as Medicare. But there are risks from failing to take theprudent actions necessary to make Medicare a better and more sus-tainable program. I think that effective competition can make alasting and meaningful improvement in this essential public pro-gram.

Thank you.The CHAIRMAN. Joe, thank you.[The prepared statement of Mr. Antos follows:]

75

The Role of Market Competition in Strengthening Medicare

Joseph R. Antos, Ph.D.

Wilson H. Taylor Scholar

in Health Care and Retirement Policy

The American Enterprise Institute

Testimony Before

The Senate Special Committee on Aging

May 6, 2003

76

Mr. Chairman and Members of the Committee: Thank you for inviting me to appear before you.I am Joseph Antos, the Wilson Ho Taylor Scholar in Health Care and Retirement Policy at theAmerican Enterprise Institute. I am also adjunct professor in the School of Public Health at theUniversity of North Carolina at Chapel Hill. I have previously served as the assistant director forhealth and human resources at the Congressional Budget Office, and earlier held several researchand management positions in the Health Care Financing Administration, the precursor to theCenters for Medicare and Medicaid Services (CMS). The views I present today are my own, anddo not represent the position of the institutions with which I am associated.

The Medicare program faces unprecedented challenges. Medicare's benefit structure isoutmoded and inadequate, failing to cover outpatient prescription drugs or to provide adequatefinancial protection for millions of enrollees. Physicians, hospitals, and other providers havedeveloped new and better ways to diagnose, treat, and cure diseases-causing Medicarespending per enrollee to grow rapidly. The impending retirement of 78 million baby-boomers,beginning in just 8 years, will rapidly escalate demands on Medicare's finances.

These challenges cannot be avoided. Steps must be taken to improve and strengthenMedicare so that it can meet the changing needs of seniors and the disabled, now and in thefuture. There is a model for such a reform in the Federal Employees Health Benefits Program(FEHBP), which has served the health insurance needs of federal workers, their dependents, andretirees for over 40 years.

Any proposal to modify a program as popular as Medicare raises concerns among policyexperts and the general public. Much controversy has developed over the role privatecompetition should play in reforming Medicare. Although the current and future problems of theprogram are widely acknowledged, there is concern that the cure might be worse than thedisease. The following arguments have been raised against reform proposals that would enhancethe role of private plans in Medicare:

* Private plans would be less successful than Medicare in controlling spending.* Private plans would limit access to health care providers.* Private plans would systematically exclude older, sicker Medicare beneficiaries.* Private plans are unreliable and are likely to drop out of the program with little warning.

My testimony today will address these serious charges. It is essential that we craft areform that assures a better Medicare program that is more responsive to the needs ofbeneficiaries, and that places the program on a sustainable financial footing for the long term. Iwill argue that private competition is an essential element in achieving those goals efficiently andequitably. But the way in which private competition is introduced matters greatly. A poorlydesigned reform proposal could make matters worse.

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Does Medicare Control Costs Better than the Private Sector?

A recent analysis by Boccuti and Moon argued that Medicare has been more successful than theprivate sector in constraining spending growth over the long term. They ascribe this success inpart to the system of government price setting and regulation that has been the hallmark of theMedicare program. But a closer look at the evidence suggests that the private sector hasperformed as well or better than Medicare in constraining cost growth.

Between 1970 and 1999, private insurance spending grew 18 percent faster thanMedicare spending. That figure accounts for differences in enrollment patterns and is restrictedto comparable benefits, in this case hospital and physician services only (see the Appendix fordetails of the calculation).

But private insurance became more generous over that time period, covering a growingproportion of the total cost of health services. In 1970, private insurance paid for about 60percent of the total private cost of hospital and physician services. By 1999, that had grown to85 percent. This expansion in generosity is not the result of adding new types of benefits (suchas a prescription drug benefit), since the analysis is confined to hospital and physician services.Instead, it reflects a shift away from out-of-pocket payments toward more first-dollar privateinsurance coverage-a shift promoted by federal tax preferences for employment-basedInsurance.

Accounting for the increasing generosity of private coverage appears to reverse theBoccuti/Moon conclusion. Although private insurance spending has risen faster than Medicarespending over the past thirty years, the unit cost of private coverage grew more slowly.2 Thatsuggests that Medicare does not have an advantage over the private sector in limiting the growthof health care spending.

This is like comparing two boxes of cereal in the supermarket. The large box is moreexpensive than the regular size. In other words, if you buy more cereal, it costs more. But thecost per ounce of cereal is lower with the large box.

We should be careful not to make too much of these calculations. It is difficult to makeall the adjustments that would be necessary for a completely accurate comparison. In particular,adjustments should be made to reflect any changes in Medicare's generosity, parallel to theestimate for private insurance. That is not possible with the National Health Accounts data usedhere and in the earlier study. However, any error is not likely to be great since Medicare'sbenefit package has remained largely unchanged for decades.

Other comparisons confirm that Medicare does not have an advantage over the privatesector in controlling spending. The Federal Employees Health Benefits Program and theCalifornia Public Employees' Retirement System (CalPERS) are large public programs thatpurchase health insurance on the private market. Over the past decade, FEHBP's averagespending growth was slightly higher than Medicare's while CalPERS' spending growth wassomewhat lower.3

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Two glarng differences between Medicare and the other public programs should benoted. First, Medicare does not have a prescription drug benefit. Consequently, it did not haveto deal with rapid spending increases in drug spending that occurred over the last few years.Second, Medicare has experienced serious disruptions in the delivery of care not shared by theother programs. Flawed government pricing formulas have helped drive HMOs from theMedicare program and threatened access to physician services in some markets.

Recent experience with physician payment reveals the difficulties of government pricecontrols.. (HMO payment issues are discussed in a later section.) In 2002, Medicare reducedphysician fees by 5.4 percent following the congressionally-mandated "sustainable growth rate"formula. This unprecedented across-the-board reduction was intended to recoup excess spendingfor physician services that occurred in earlier years.

Reports from some parts of the country indicated that certain physicians were closingtheir practices to new Medicare beneficiaries. This did not show up as a decline in the overallparticipation rate of physicians, but it nonetheless was a disruption of service to some patients.

Ironically, the rate cut did not save money. Although some physicians were paring backtheir Medicare business, others reacted to the fee cut by increasing the volume of services paidby the program. Medicare physician payments increased by nearly $3 billion even though theaverage fee for each service was reduced. That was the result of an abnormally large increase inservice volume-a 7.9 percent increase in 2002 compared to 3.5 percent increases in 2000 and2001, when fees increased.4 It would be difficult to argue that such a sharp increase in volumelast year was justified solely on clinical grounds.

This illustrates a problem common to price setting methods in Medicare's fee-for-servicesystem. If the administered price is reduced below the market price, providers find ways to makepart of the reduction up by expanding services. Tighter controls that also restrict the use ofservices could prevent that, but such restrictions would have adverse consequences for the healthof beneficiaries.

Would Medicare Beneficiaries Have to Change Doctors?

The fear of having to find a new doctor because of changes in Medicare policy is palpable.Medicare beneficiaries often develop close ties with their physicians, and there can be adversehealth consequences if a patient shifts to another physician during the course of treatment. Thetraditional Medicare fee-for-service program places no direct limits on which providers a patientmay see. This offers flexibility and an important sense of security to many beneficiaries, but itcomes at a significant cost.

The structure of traditional Medicare reflects the insurance practices that existed in 1965at the inception of the program. Medicare does not cover important services, including

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outpatient prescription drugs and many preventive services. It imposes a confusing, inequitable,and inefficient cost-sharing structure on beneficiaries. And the program fails to provide financialprotection for those with the highest health costs.

Most beneficiaries supplement their Medicare benefits to overcome many of those gaps.Such additional coverage is available through private Medigap insurance, employer-sponsoredretiree plans, Medicaid, and Medicare managed care plans. About 91 percent of beneficiarieshave supplemental coverage.5

The cost to beneficiaries of the traditional Medicare program depends to a large extent onwhether they are eligible for or can afford to purchase supplemental coverage. The 4 millionpeople who qualify for Medicaid benefits have relatively low out-of-pocket spending, roughly$750 in 2000.6 About 10 million people buy Medigap policies, spending on average about$3,600 out-of-pocket in 2000. Supplemental insurance premiums accounted for about $1,700 ofthat total.

The conclusion is clear Although traditional Medicare allows a wide choice of providers,nearly everyone is saying they want something different than what the government allows. Theflexibility of the traditional program comes at an additional cost of thousands of dollars tomillions of beneficiaries.

A reform modeled after FEHBP would offer beneficiaries a broad set of options, not justplans that restrict access to a specific panel of doctors. Health plans that rely on closed panels ofproviders and intrusive management of care have given way to more flexible plans that are thenorm in the private market today. About 70 percent of workers with insurance from an employerare in preferred provider organizations (PPOs) or point-of-service plans (POSs), which allowbeneficiaries to go to the provider of their choice. Such options, as well as HMOs and thetraditional fee-for-service plan, should be made available to Medicare beneficiaries. Abeneficiary who wants to remain in the traditional program should be allowed to do so.

Should we give beneficiaries in traditional fee-for-service a prescription drug benefit thatis similar to the benefit that would be offered by competing plans? Pharmaceuticals havebecome one of the essential tools of modem health care. If we did not add a drug benefit totraditional Medicare, we would not be able to take advantage of new therapeutic approaches andmethods for controlling cost. Disease management programs, which manage the care of high-cost patients and promise both cost savings and better health outcomes, cannot function unlessprescription drugs are part of the benefit. But health plans should be allowed to structure theirbenefits to foster efficiency, and they should be able to pass savings back to their enrollees(perhaps through lower premiums). A one-size-fits-all approach will not work.

A concern also has been raised that PPOs typically charge more when patients go out ofnetwork for treatment. The Blue Cross Standard Option in PEHBP, for example, requires anenrollee to pay $15 for a standard office visit to an in-network doctor or 25 percent of the chargefor a doctor who is out of the network. Such differences in beneficiary cost sharing can amountto substantial sums for someone who chooses to receive most of her care out of the plan's

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network. That places a responsibility on beneficiaries to make their plan choices carefully.assuring that they can stay within the network for most services and keep their out-of-pocketspending low.

Beneficiaries need good information to make sound choices. The Office of PersonnelManagement, which operates FEHBP, provides comparative information on health plans(including lists of preferred providers). Private groups also publish information to guidebeneficiaries in selecting a plan.8 A similar information strategy for a competitive Medicarereform would assure beneficiaries that the plan they chose included their personal physicians.

Would Private Plans Avoid Sicker Beneficiaries?

A market-based reform of Medicare would offer beneficiaries a choice of several competinghealth plans. Under premium support models, premiums would be partly subsidized.Beneficiaries would face higher premiums for more expensive plan options. Plans would havean incentive to keep premium costs down to remain competitive. They might accomplish thatthrough improved efficiency. But they might also keep cost down by skimping on care andenrolling people with below-average health costs (the "good risks"). This is known as riskselection.

Medicare has dealt with risk selection primarily by improving the accuracy of paymentsto health plans. Methods have been developed to adjust federal payments to health plans basedon the likely cost of providing services to enrollees. If plans received larger compensation forsicker people (whose expected health costs are above average), the plans would have a greaterincentive to enroll them.

Medicare's current risk adjusters are based mostly on demographic factors (including theage, sex, and Medicaid status of the enrollee), with only limited information on the actual use ofservices. New methods have been developed that should be more effective in predictingdifferences in health spending among beneficiaries. CMS recently announced that it wouldbegin to phase in a "selected significant condition" model in January. That new model isexpected to make more accurate payments for the sickest patients, rewarding plans that cangenerate real cost savings through disease management. That could become an important toolunder a more competitive Medicare program.

Risk selection is probably not a major problem for beneficiaries in the current Medicareprogram since most are enrolled in traditional fee-for-service. But how much of a problemwould risk selection pose under a market-based reform? Evidence from FEHBP suggests thatthe problem could be negligible, depending on the design of Medicare's reform.

FEEBP provides a generous premium subsidy to enrollees, equal to 75 percent of thehealth plan's premium subject to a dollar cap. Payment risk adjusters are not used, andemployees can freely choose among plans in their area during the annual open enrollment

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season. One might expect to find substantial risk selection across plans under thosecircumstances, with higher-cost plans attracting an older and sicker group of enrollees. But arecent study by Florence and Thorpe'0 found very small differences in the average age ofenrollees in low- and high-cost plans because FEHBP pays such a large portion of the premium.

The potential for risk selection in FEHBP (and other choice-based systems) is alsolimited by the inertia most people exhibit when given the opportunity to change health plans.Francis' found that many FEHBP enrollees who could save money by changing plans duringopen season fail to do so. Inertia in personal decision making helps to stabilize plan enrollment,reducing-the chances that more generous plans would be driven out of the market by the cost ofattracting sicker enrollees. But that also implies that beneficiaries would pay more than theywould have if they were willing to change plans.

If most people don't change plans, how is a choice system supposed to work? Indeed,how do markets work if most consumers remain loyal to their favorite brands? A competitivemarket will generate pressures on plans to lower costs or improve their product so long as someconsumers are prepared to shift to a competitor. The credible threat of a loss of market share-or the prospect of gaining market share-is sufficient incentive in a competitive market.

These arguments do not imply that we can be complacent about risk selection under areformed Medicare program. Health markets are far from the competitive ideal, and theconsequences of a poorly functioning choice system could be quite serious for an olderpopulation.

Beneficiaries and their families will need reliable user-friendly information about planoptions. Techniques including improved payment risk adjusters will help, particularly in aprogram that provides large premium subsidies. The Medicare agency must be vigilant in itsoversight, ready to take corrective action when necessary. But prudent oversight does not haveto mean a large increase in administrative costs. The Office of Personnel Management (OPM)successfully manages FEHBP with a handful of staff and minimal regulatory requirements.

Would Private Plans Stay in the Program?

Recent experience with private health plans in Medicare+Choice has been sobering. In the mid-to late-1990s, Medicare HMOs were highly competitive with the traditional fee-for-serviceprogram; offering better benefits at a reasonable price. Congress created Medicare+Choice in1997, intending to expand the number of private plan choices available to beneficiaries.Participation in Medicare+Choice peaked in 1998 at 346 plans, and that number has droppedever since. This year only 153 contractors remain in the program.

Millions of Medicare beneficiaries have had to change health plans over the past fiveyears as the Medicare+Choice program shrank. Although most beneficiaries affected by plandropouts could turn to other managed care plans, and all beneficiaries could enroll in thetraditional fee-for-service program, this kind of disruption could have adverse health

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consequences for some people. These developments have been taken by some observers asevidence that competition cannot work in Medicare.

That's half right. Plans will not be able to compete in Medicare unless we also changethe government's approach to managing the program. Medicare+Choice did not break awayfrom Medicare's history of top-down price setting and complex regulations. Administrativeinflexibility, unrealistically low payments, and an inability to adjust to changing marketconditions were key factors leading to the decline of Medicare+Choice.

In broad terms, Medicare's experience with managed care parallels that of the privatesector. After initial enthusiasm that HMOs would be able to control health costs, consumers andproviders began to reject the constraints imposed by such plans. The goal of cost containmentbecame less important in a booming economy and a tight labor market. Consumers shifted toless restrictive plan options, including PPOs and POSs. Providers demanded and got larger feeincreases, driving premiums up.

Those changes were led by consumers, and the market responded by offering newoptions. Traditional managed care plans lost market share relative to the new plans, whichoffered a more attractive package of benefits, premiums, and cost containment practices.

In contrast, Medicare+Choice was locked into a set of requirements by the 1997legislation and did not have the authority (or experience) to make changes necessary under thenew circumstances. For example, most Medicare+Choice plans could expect only a 2 percentannual increase in federal payments even though their cost of providing care was growing at 10percent a year or more. It is not surprising that plans left the program.

Medicare cannot be immunized from the pressures of the wider health care market. Itcan, however, become a smarter purchaser of health care, and it can become more responsive tothe demands of its beneficiaries. Medicare should not be afraidlo drive a hard bargain withhealth plans and expect them to provide excellent care. tut Medicare must also be allowed torespond to changing circumstances before problems get out of hand that can result, as we haveseen, in the exodus of plans from the program.

Elements of a successful Medicare choice program are contained in FEHBP. Rather thansetting into law detailed pricing formulas and other requirements that often do not stand the testof time, OPM has broad discretion to negotiate rates and conditions of plan participation. It hasthe ability to accept new health plan options (other than new fee-for-service carriers) withoutnew legislative authority, but it remains accountable to Congress. Such principles should beincorporated into a market-based reform of Medicare.

Conclusion

Congress has an opportunity to help Medicare fulfill its promise to millions of seniors and people

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with disabilities. We can build on Medicare's successes, but we need not repeat its mistakes.The program must expand to cover prescription drugs, preventive benefits, and protection againstuncapped medical costs. The program must be made financially sustainable if the taxpayers oftoday are to receive their Medicare benefits tomorrow.

- The Federal Employees' Health Benefits Program is a good place to start. A Medicarereform modeled after FEHBP would provide both the incentive and the opportunity for seniors tochoose health plans that best meet their needs. Beneficiaries would be able to select fromcompeting plans, including a modernized fee-for-service Medicare that offers a sensible set ofbenefits. -Such a reform would also create incentives for health care providers to produce highquality care at lower cost. Medicare would remain a govemment-run program under an FEHBPapproach, assuring appropriate oversight and protection for the most vulnerable.

There are certainly risks in attempting to reform a program as important as Medicare.But there are also risks from failing to take the prudent actions necessary to make Medicare aneffective and sustainable program. Adapting the FEHBP model to the specific circumstancesfacing the Medicare population can be a successful strategy for using effective competition tomake lasting and meaningful improvements in an essential program.

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Appendix

Data from the National Health Accounts confirm that private insurance spending grew morerapidly than Medicare spending over the past three decades, even when differences in enrollmentand differences in the types of benefits covered by the different insurance programs are takeninto account. Between 1970 and 1999, spending by private insurance for hospital and physicianservices grew 18.1 percent faster than comparable Medicare spending, both measured on a per-enrollee basis (see Chart 1).

But private insurance became more generous over that time period, covering a growingproportion of the total cost of health services (see Chart 2). In 1970, private insurance paid forabout 60 percent of the total private cost of hospital and physician services. By 1999, that hadgrown to 85 percent. This expansion in generosity is not the result of adding new types ofbenefits (such as a prescription drug benefit), since the analysis is confined to hospital andphysician services. Instead, it reflects a shift away from out-of-pocket payments toward morefirst-dollar insurance coverage in the employer market.

Accounting for the increasing generosity of private coverage, the unit cost of privatecoverage grew more slowly than Medicare (see Chart 3). The "unit" in this case refers to thepercent of spending covered by insurance. An insurance policy that is more generous coversmore of a person's total health spending, and thus has more "units" than a less generous policy.

We were unable to adjust Medicare spending for possible increases in that program'sgenerosity because of data limitations of the National Health Accounts. However, we know thatMedicare benefits did not appreciably increase over the three decades. Some preventive benefitswere added, for example, but all the major health services have been covered by Medicare sinceits inception.

In an attempt to verify this observation, we examined other sources of information. Dataon spending for all health services is available from the National Health Care Expenditures Study(NHCES) for 1977 and the Medical Expenditure Panel Survey (MEPS) for 1996. We calculatedthe percent of total spending paid by private insurance for people under age 65, and thecorresponding percent of total spending paid by Medicare for people 65 and older. This estimateis not limited to hospital and physician spending, and is consequently not directly comparable tothe earlier analyses.

The value of Medicare has not kept pace with private insurance (see Chart 4). Forpersons under age 65, the generosity of private health insurance grew by 41.5 percent between1977 and 1996. For persons 65 and older, the generosity of Medicare grew by only 22.2 percentover the same period.

Comparisons using National Health Accounts data cannot prove the superiority of onemodel of cost containment over the other. Private insurance spending includes spending onbehalf of Medicare beneficiaries, many of whom have private retiree policies or private Medigap

85

insurance that supplements their Medicare coverage. The spending data cannot account fordifferences in the age, health status, or other characteristics of the beneficiary population, whichclearly affect the use of health services. The direction of any bias caused by inadequate datacannot be determined.

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Chart 1Private Insurance Spending Grew Faster than Medicare

A Cost per Participant(Hospital and Physician Services)

C 1,6001,400'-

8 _ _000°___ -Private Health

o $ 800 _ .......... _ . ~~~~~~~~~Insurance Only01600

> 400 _-__ -200 1001 - Medicare

= 0

fb 0t 0 C 0) 0C 0° t 0c

Year

Source: Naionral Health Axccouts.Note: Priate health bsrerce data not adjusted o, rthe increasing generosity of private health Insurece during 1970-99.

87

Chart 2Generosity of Private Insurance Grew Dramatically

(Hospital and Physician Services)

' 100%E 85.4%

fiS80% .r: -80/a 59.6%60% W C l

&L 400/%.

207 .-

&T 0%.

1970 1999

Snwe. NatinaI Heafh Acool.

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Chart 3Private Spending (Controlling for Generosity) Grew

Slower than MedicareCost per Participant

(Hospital and Physician Services)

1;6001,4001,200 -1,000 -

800 -

600 -400200 -

00 CM (0 O t c

cX0 c 0) CZ 0)0) 0) 0) 0) 0)

-Private Health InsurancnAcdusted forImproxernent InInsuronce's Generoioty

-Medicare

Source: National Health Accounts YearNDWte. Rivate health insurence data adjusted fur the increasing generosiy of private hisurance during 1970-99: thbadjustrrent woas perfrrroed by accorunting for dinplacenent of pricate out-uf-pocket spending by irsurance

0)

C

"Cc0

m0 0C°. a)

Ec)

_. .~~~

89

Chart 4Growth In Insurance Generosity, 1977-96

(All Health Spending)

50%

E40

* e 30% -

,& 20% -_ Si, G

a10% -0i L10

2iao

41.5%

22.2%

Unt0 f

Private (under age 65) Medicare (65 plus)

Smnurne: Natinral Health Care Expenditure Survey (1977), Medical Expenlditure Panel Survey (1996).

90

1. Cristina Boccuti and Marilyn Moon, "Comparing Medicare and Private Insurers: GrowthRates in Spending Over Three Decades," Health Affairs (March/April 2003), pp. 230-237.

2. "Unit" refers to the percent of spending covered by insurance. An insurance policy that ismore generous covers more of a person's total health spending, and thus has more 'units" than aless generous policy.

3. Medicare Payment Advisory Commission, Report to Congress: Medicare Payment Policy,March 2003, pp. 11-12.

4. The increase in the volume of services are estimated as the increase in total allowed chargesless the fee update and the increase in fee-for-service enrollment. Unpublished data are availablefrom the Office of the Actuary, CMS.

5. Medicare Payment Advisory Commission, Report to Congress: Assessing Medicare Benefits,June 2002, p. 17.

6. Glenn M. Hackbarth, Testimony before the Subcommittee on Health, Committee on Waysand Means, U.S. House of Representatives, May 1, 2003.

7. The Kaiser Family Foundation and Health Research and Educational Trust, Employer HealthBenefits: 2002 Annual Survey (Menlo Park and Chicago: KFF and HRET, 2002), Exhibit 5. 1, p.69.

8. See, for example, Checkbook's Guide to Health Plans for Federal Employees, producedannually by the Center for the Study of Services, Washington, DC.

9. The term "nsk" is often misused in discussions of health insurance. Risk denotes uncertainty.But insurers usually consider people who have a high expected cost of care to be "poor risks."For example, people with AIDS are virtually certain to incur high health care costs, but they arecalled poor risks. The text applies the term as it is commonly (mis)understood.

10. Curtis S. Florence and Kenneth E. Thorpe, "How Does The Employer Contribution For TheFederal Employees Health Benefits Program Influence Plan Selection?," Health Affairs(March/April 2003), pp. 211-218.

11. Walton Francis, Testimony before the Subcommittee on the Civil Service, Census andAgency Reorganization, Committee on Govemment Reform, U.S. House of Representatives,December 11, 2002.

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The CHAIRMAN. Our final panelist is Jeff Lemieux, a SeniorEconomist at Progressive Policy Institute and previously seniorstaff with the 1999 Presidential Medicare Commission and a CBOeconomist.

Jeff, welcome to the committee.

STATEMENT OF JEFF LEMIEUX, SENIOR ECONOMIST,PROGRESSIVE POLICY INSTITUTE, WASHINGTON, DC

Mr. LEMIEUX. Thank you, Mr. Chairman.Mr. Chairman, your staff asked me to comment very specifically

on the cost studies that Dr. Antos and Dr. Moon have done re-cently.

The CHAIRMAN. We know that that is an important part of thisdebate, and as Senator Stabenow point out, it is current within thediscussion this morning with the New York Times article, so it isfront and center to all considerations, I suspect.

Mr. LEMIEUX. Let me get right to that, but first let me make justthree quick assertions in response to the discussion that we haveheard in both panels.

I think that there are three conditions that are necessary tomake an FEHB-style system workable in Medicare. First, the gov-ernment-run plan needs added flexibility to shape its benefits andpayment systems more along the lines that Abby Block told us arepossible in FEHB.

Second, the private health plans in Medicare clearly need a sta-ble, predictable, and fair platform from which to make business de-cisions, and that also is lacking.

The third thing that I think is lacking that we need to work onis that both Congress and the public will need a very thorough un-derstanding of how a competitive choice system in Medicare wouldwork. We need to create a win-win situation here for beneficiariesand taxpayers, and we need to know how an FEHB system wouldplay out over time before policy decisions can be made, and wehave not made that analytic effort yet in Congress.

To these comparisons, in my opinion, Dr. Moon and Dr. Antos es-sentially say the same thing. They say that if you look at Medicareand private insurance spending trends over 30 years, it looks likeMedicare's are slightly better. I believe Dr. Antos is also correctwhen he says that when you fold in benefit generosity, the cost-benefit comparison, it looks like private plans are a little better.

So my analogy to this-and I am not trying to be funny, but Ithink this is appropriate-is that Dr. Moon is arguing that McDon-ald's is better than Burger King because its burger prices have in-creased by a few pennies less over 30 years, and that Dr. Antos issaying no, Burger King is actually a better value than McDonald'sbecause Burger King's food is improving at a faster rate.

This is the sort of data that policy wonks on both sides of thepolitical aisle are going to use for ideological ammunition. Backersof the government-run fee-for-service program will argue thatMcDonald's is better than Burger King, and backers of private planoptions in Medicare will say that Burger King is better thanMcDonald's. But the larger point is that policymakers should nothave to choose Burger King or McDonald's. Beneficiaries should beable to choose from Burger King, McDonald's, Popeye's, the gour-

92

met shop-you name it-and that our esteemed foundations andpolicy think tanks could do the most accurate and subtle computa-tions possible, and we would never be able to determine a correctanswer on something that is really a point of preference.

So in my opinion, comparisons of long-term spending cannot real-ly possibly settle a debate over which sector is a better value be-cause Medicare and private health insurance spending are inter-related. When Medicare finds ways to save money, private insurersface pressure, mostly from employers, to mimic those savings or tocome up with alternative savings.

Likewise, when private health insurers find a way to save moneyor add value and benefits to their packages, then Congress facespressure to improve Medicare, to find similar savings or similarbenefit enhancements. The spending trends on both sides reflectthese pressures, they tell us nothing intrinsic to government-runprograms or private health insurance.

The first major move toward cost containment in the entireUnited States health sector was in the early 1980's when Medicaretook the lead on cost containment and implemented a prospectivepayment system for inpatient hospital care. This was a paymentcontrol method that worked. Hospitals changed their behavior, andMedicare's costs slowed down from the double-digit rates to singledigits, which was unheard of at the time.

That is why Medicare's cost performance moved better than pri-vate insurance for several years. After about 1993, private healthinsurance and Medicare have gone back to increasing at about thesame rates. What happened was that private insurers becameaware that Medicare was paying less for hospitalization, so theyhad to do something about it. Employers put pressure on them. Ofcourse, they could not implement a massive payment control sys-tem of their own; they could not collude to gain market power todo that, and the market would not allow them to just impose pay-ment restraints. But by the early 1990's, they found a solution.That solution was managed care. By targeting their enrollees tospecific hospitals and doctors, they could gain leverage to get betterdeals with health care providers.

That sudden cost saving success in managed care then led to po-litical actions that turned around and helped to reduce Medicarespending again, first in 1996 with the anti-fraud provisions, in1997 with payment cuts. Also, it sparked a political debate onMedicare's benefits. If these private plans through managed carewere able to save money and offer better benefits, that really point-ed out how Medicare benefits had fallen behind.

Of course, some of those early managed care savings have provedfleeting, but there has been one durable item of cost saving thatmany people on this panel and the previous panel have mentioned,and that is care management-the ability to take care of peoplewith one or more chronic diseases in a much better way. I thinkthis is the new potential win-win in Medicare. PPI's health plan isfocused on care management and healthy aging, and it goesthrough several different ways to do it-a way to do a drug benefitthat would improve that sort of thing and would also help improverisk adjustment; an accountability system so the fee-for-service

93

plan can keep up with these sorts of innovations; and the new sortsof choices that we have talked about on the panel.

With that, I mention in my written statement a fair bit moreabout the PPI health plan, and I encourage you to take a look atit if you have a chance. Thank you very much.

[The prepared statement of Mr. Lemieux follows:]

94

Ira, TestimonyMay 6, 2003

McDonald's v. Burger KingA "Nothing Burger" Debate on Medicare Reform

Testimony before the Special Committee on Aging, US. Senate

by Jeff Lemieux

Thank you Senator Craig, Senator Breaux, and committee members for inviting me. My name is JeffLemieux, and I am the senior economist for the Progressive Policy Institute (PPI). My statement focuseson (1) comparisons of spending trends between govermment-run Medicare and private health insurancecoverage, and (2) Medicare competitive choice systems, within the context of a reformed and modernizedMedicare system. Here are the main points:

For polcymaking, comparisons of long-term spending trends between Medicare and private healthinsurance cannot possibly settle a debate over which sector is a better value. That is because trendsin Medicare and private health insurance spending are interrelated. When Medicare finds ways tosave money and add value, private insurers face pressure from employers to minic those efficienciesor find alternative savings. When private health insurers find ways to save money or add benefitsand value, Congress faces pressure from the public to enact similar cost savings or benefitenhancements in Medicare. Spending trends reflect those pressures-they tell us nothing aboutanything intrinsic to either government-rnm or private health insurance.

0 In my opinion, policymakers should assume that the advocates of government-rn health insuranceand private health insurance are both correct Each type of insurance is more efficient than theother. Then, the logical conclusion for Medicare policy would be for the federal government tocreate a level playing field for both types of coverage, possibly patterned after the Federal EmployeesHealth Benefits (FEHB) program. Let both govenmuent-run and private health plans compete forseniors' business, and let the competition directly and quickly pressure both types of coverage tofind efficiencies, new and helpful benefits, and other value improvements for both seniors andtaxpayers. Direct competition and choice would be a more efficient way for each sector to matchthe other's improvements It would be faster, less cumbersome, and less error-prone than waitingfor the political process to improve Medicare when it falls behind, or waiting for employers to forceimprovements in private health insurance when private plans lag.

o For direct competition and choice to work for the benefit of both seniors and taxpayers, thegovernment-run plan needs added flexibility to shape its benefits and payment systems. Likewise,private health plans in Medicare need a stable, predictable, and fair platform from which to makebusness plans. Congress and the public need a thorough understanding of how competitive choicesystems in Medicare would work and play out over time before policy decisions can be made. Theseconditions are not present in Medicare.

0 The main efficiency improvements in both Medicare and private health insurance over the last twodecades have been reductions in overpayments to health care providers. Although there may stillbe overcompensated providers in some parts of the health care system, that method of efficiencygain has largely run its course.

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Progressive Policy Institute www.pplonllne.org

P Future gains in efficiency will probably result from improvements in the quality of healthcare, especially for patients with chronic illnesses. These improvements will range frombasic error reduction measures to rudimentary educational or disease managementprograms for seniors with a particular chronic illness, such as diabetes, to sophisticatedcase management, home-based monitoring, and community support services for patientswith multiple chronic conditions.

PPI believes that the next great challenge for Medicare will be shifting the program's emphasistoward chronic care. Medicare has always been a reliable bill payer when beneficiaries sufferedan acute health care crisis requiring hospitalization or extensive medical procedures. Now,Medicare must learn how to better help the increasing number of seniors with chronic illnessesstay out of the hospital and maintain the best possible health and quality of life. This, we believe,is key to improved health outcomes, higher quality health care, and greater value for evervhealth dollar spent.

PPI's Medicare reform proposal, the "ABC" proposal, is focused on chronic care and healthyaging.' Its three main elements are:

0 Accountability: a radical decentralization of Medicare's administration, so that localMedicare administrators and medical directors are directly empowered to create diseasemanagement and health improvement programs targeted to the needs of beneficiaries intheir area;

i Benefits: a drug benefit structure that helps link, not fragment, Medicare benefits andprovides information to target disease management programs; and

Choices: a much expanded menu of private insurance plans in Medicare, along withlocally-run comprehensive disease and care management programs for fee-for-servicebeneficiaries with specific or multiple chronic conditions.

Medicare reform is an attempt to create better health for seniors and better value for bothseniors and taxpayers. By my definition, reform is an attempt to create a "win-win" situation.By contrast, current proposals for Medicare drug benefits generally create a "win-lose" scenario:Beneficiaries win by getting new benefits (maybe) and taxpayers lose by incurring new obligationswith little or no hope for offsetting savings. Setting aside the important question of which groupof citizens is more deserving, citizens as Medicare beneficiaries or citizens as taxpayers, we haveswitched the Medicare debate from reform to redistribution.

I believe that two fundamental reforms should be considered: (1) the development of anFEHB-style competitive choice system, and (2) the development of an infrastructure forimprovements in chronic care, both in private plans and the govemment-run system. Both ofthese reforms have potential to create "win-win" outcomes.

The primary impediment to an FEHB-style system is analytic: Medicare is too important tolaunch into reforms without careful planning and analysis of the likely impact of change. Wemust be very sure that a "win-win" situation would result. In the absence of the needed analysis,Medicare reform has been stymied, to the detriment of the Medicare debate.

Medicare and Private Health Insurance Spending: McDonald's vs.Burger King

Both Marilyn Moon of the Urban Institute and Joe Antos of the American Enterprise Institutecalculate that per-enrollee Medicare and private health insurance spending for some comparable

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services grew at nearly identical rates until the mid-1980s.2

After that point, Medicare spendinggrew slightly more slowly for several years. But starting in about 1993, growth in spending ineach sector returned to a roughly equivalent rate. Because Medicare grew more slowly between1986 and 1993, its per-enrollee spending has risen by a little less over a 30-year period, so bythat measure, Medicare's cost performance seems slightly better.

However, Dr. Antos is correct that the actuarial value of private health insurance benefitsgrew more rapidly than the value of Medicare benefits during this period. Therefore, whengrowth in benefit generosity is taken into account, the private health insurance "cost-benefit"performance seems better.

By analogy, Dr. Moon argues that McDonald's is better than Burger King because its burgerprices have increased by a few pennies less over time. Dr. Antos counters that Burger King isn'tless efficient than McDonald's if you consider that Burger King's food has improved at a fasterrate; in fact, by his calculations Burger King is a better value.

Policy wonks on both sides of the political aisle will use these calculations as ideologicalammunition in the meta-struggle for or against goverrunent-rnm or private health insurance.Backers of the government-run Medicare fee-for-service program argue that Medicare shouldbe like McDonald's. Backers of private insurance options in Medicare argue that policymakersshould choose Burger King.

Of course, health insurance is more important than convenience food, and I don't mean todemean the importance of these calculations.

But the larger point is: Policymakers should not have to choose whether Medicare beneficiariesget their insurance from government-run or private health plans. Instead, beneficiaries should beable to choose from among the health insurance equivalent of McDonald's and Burger King, aswell as Wendy's, Popeye's, Taco Bell, the organic market, the gourmet shop, or even a home-cooked snack.

Our great foundations and policy institutes and scholars could do the most accurate andsubtle calculations, but they could never definitively determine whether McDonald's was betterthan Burger King, or if the Beatles were better than the Rolling Stones, or, for that matter,whether fat guys really drink Lite beer because it "tastes great" or is "less filling."

One other point is clear: Competition and rivalry between different types of fast food jointsor health insurance plans helps spur innovation and progress. Certainly, the spending andbenefit trends in Medicare and private health insurance bear this out.

Medicare and Private Cost Containment Efforts and BenefitEnhancements are Related

Prior to the mid-1980s, both Medicare and private health insurance were the same type ofproduct: fee-for-service insurance with a relatively narrow scope of benefits and few limits.

Medicare made the first move toward cost savings in 1983, with the enactment of theProspective Payment System (PPS) for inpatient hospital payments. This was the first innovative,large-scale payment control method anywhere in the U.S. health sector, and it was effective.The number of hospital inpatient beds, which had grown steadily for decades, suddenly startedcontracting as the PPS system was implemented. Medicare's costs dipped from double digit topreviously unheard of single digit growth rates in the mid-1980s.

Gradually, private insurers became aware that Medicare was paying considerably less forhospital care. A series of studies in the early 1990s by what was then called the ProspectivePayment Assessment Commission (ProPAC) asserted that Medicare typically paid about 90percent of the hospitals' costs of treating Medicare patients, while private insurers paid about130 percent of costs. (Those studies were somewhat off base, because they seemed to assumethat hospital costs were independent of Medicare and private insurers' willingness to pay. But

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nevertheless, it was clear to employers that the private insurers were paying much more thanMedicare for inpatient hospital care.)

Of course, private insurers could not collectively implement a massive payment controlsystem of their own. They could not collude to gain sufficient market power, and they could notindependently impose payment restraints because of market conditions.

However, by the early 1990s, private insurers found a way to get payment reductions oftheir own: managed care. By steering patients to certain hospitals or doctors, health plansgained leverage to negotiate better deals.

As a result, the growth private health insurance spending for emplover-based coveragetumbled in the mid-1990s. (In the statistics used by Drs. Moon and Antos, continued rapidgrowth in private Medigap and retiree insurance spending on behalf of Medicare beneficiariesoffset some of the decline in emplover-based premiums.)

With managed care savings, private plans were able to slow cost growth and offer enhancedbenefits, usually with low co-payments for each service. The growth of private insurance planenrollment in Medicare skyrocketed.

Managed care's sudden cost-saving success led to political actions that dramatically reducedMedicare's spending. First, anti-fraud and abuse controls were tightened in 1996. In 1997, theBalanced Budget Act sharply reduced payments to health providers. As a result, the growthMedicare spending tumbled in the late-1990s.

Medicare's benefits also became a political topic. The absence of retail prescription drugbenefit in the government-nrn plan suddenly became a political issue in late 1998 and early1999, and it has remained a hot issue to this day.

At the same time, some of the early managed care savings proved fleeting, as health careproviders consolidated and rebelled against tight payment controls from private insurers.However, one private sector approach has proved durable: helping provide coordinated carefor patients with chronic illnesses.

Although Medicare started the cost-cutting trend in the 1980s, it is private-sector innovationswith disease and case management for patients with chronic illnesses that offer the best hopefor quality improvements and savings looking forward.

Chronic Care, Healthy Aging, and PPI's Medicare Proposal

To foster improved chronic care and disease management in Medicare, PPI encouragesCongress to consider two simple tests for any legislative proposal:

0 No new silos. Separated, unlinked, or uncoordinated benefits can thwart diseasemanagement efforts. Congress should scrap the idea of a preminm-based stand-alonedrug benefit. In general, health benefits should be integrated under one administrativestructure, so that the insurer has the ability and the incentive to evaluate tradeoffs-forexample, adding drug benefits known to reduce the incidence or cost of hospitalizations.Even if benefits cannot be fully integrated under one insurance carrier, at the very leastthey should be.linked, so that information can be shared between primary andsupplemental insurers. Adding another separate, add-on benefit to Medicare's current,outdated structure would work against disease management and comprehensive,coordinated care for people with chronic illnesses.

0 No new benefits without accountability. It doesn't make sense to add benefits withoutmaking fundamental changes to Medicare's processes, so that we can learn whether ornot the benefits improved seniors' health. Even preventive and screening benefits shouldbe accompanied by permanent evaluation systems designed to identify and help people

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who are at risk for particular problems or are coping with multiple ailments. All newbenefits must help reorient the Medicare program toward more optimal care of chronicillness and be accompanied by new processes to spur systematic improvements in healthcare quality and outcomes.

The Centers for Medicare and Medicaid Services (CMS) needs the flexibility to create diseaseand care management programs for Medicare beneficiaries. However, Congress is not going togive the CMS bureaucracy vast new powers without greatly enhanced accountability andoversight systems. Moreover, disease management is inherently a local system, requiringcooperation between local health providers, community institutions, consumer and seniors'groups, and, in some cases, local government agencies. The Centers for Medicare and MedicaidServices.cannot run effective localized disease management and health improvement programsfrom its headquarters in Baltimore.

The Progressive Policy Institute's proposal is explained in greater detail in the report An'ABC' Proposal to Modernize Medicare, which contains several similarities with a prescnptiondrug bill introduced by Rep. Cal Dooley (D-Calif.) in the House last month (H.R. 1568). Hereare the basic elements of the PPI proposal:

Accountability. Medicare officials should be held accountable for measuring and improvingthe health of older Americans. They should be given the freedom to make improvements at the locallevel, in accordance with local needs, with dear public disclosure of results and Congressionaloversight. The model for the PPrs proposal is the "ComnpStat" system developed in New York Citytohelp fight crime. In thatsystem, crime trends were tracked inreal time, and localpolice commanderswere given flexibility to deploy resources as needed in their precincts in exchange for realaccountability for their crine-fighting plans and success. Unsuccessful commanders who did nothave a credible plan for performance improvement were replaced.

We propose that Congress create approximately 150 local Medicare administrative regions andstaff each local area with a Medicare medical director and Medicare local administrator We believethose officials should be given flexibility to create new progrsins to improve health in their areas,with budget authority to create local programs that are budget-neutral within a 10-year period.Local officials would be ranked annually an their ability to foster improvements in health qualityand outcomes mn their regions, and Congress would establish a new congressional agency, pattemedafter the Joint Committee on Taxation, to oversee the local officials' actions, proposals, programs,and ratings. Local administrators with poorer performance results would be replaced. Medicare'scentral bureaucracy would be reduced as the local officials were put in place.

Benefits. The Progressive Policy Institute believes the most realistic and workable Medicaredrug benefit would be a universal, zero-premium catastrophic benefit, provided mostly throughthe supplemental insurers that already serve Medicare beneficiaries, including employment-based plans, Medigap plans, and state programs. (Seniors without any supplemental benefitswould choose a discount card that also provided the catastrophic drug benefit.) The catastrophicbenefit would be based on total drug spending; PPI proposes that the catastrophic benefitexplicitly allow seniors to have additional coverage under the catastrophic "deductible" withoutforfeiting their catastrophic benefits. By contrast, congressional proposals that base a catastrophicdrug benefit only on 'out-of-pocket" drug spending would be unfair to beneficiaries who haveand want additional drug coverage, and could disrupt the employment-based retiree coveragemany seniors receive. The Progressive Policy Institute's preferred approach is more expensivefor the govemnment, but it is more practical and workable. Under PPI's proposal, low-incomeseniors would be eligible for additional drug benefits, including up-front" benefits that startedat much lower levels of drug spending.

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We believe that universal catastrophic drug coverage would create tremendous side benefitsby building an information-based infrastructure for disease and care management programns.The CMS would obtain real-time data from the supplemental insurers and other plans anddiscount cards administering the benefit, so that Medicare would know when a patient hit thecatastrophic deductible, and Medicare's Lability was triggered. Therefore, Medicare would havea nearly real-time database of all beneficiary drug expenditures, which would help local Medicareadministrators target quality improvement and disease management programs to particulardemographic groups or regions. The new data could also dramatically improve risk adjustmentmethods, which would help private comprehensive plans stay in Medicare.

Choices. The Progressive Policy Institute proposes to revitalize Medicare's HMO programand expand the PPO demonstration program nationwide. We would establish a new type ofMedigap coverage that included some up-front drug benefits; however, to keep the cost down,the "New Medigap" plan would not have absolute first-dollar coverage of beneficiaries'coinsurance for Medicare's other benefits. Beneficianes could enroll annually in private plans,New Medigap options, and new comprehensive disease management programs, and havepremiums deducted from their Social Security checks.

Ultimately, Medicare should switch toward the FEHB model. Of course, the government-run plan would remain the dominant offering (it currently enrolls almost 90 percent of Medicarebeneficiaries). But switching Medicare to a direct menu-based purchasing system, with all healthplans-including the government-run plans-treated as equals, would be more efficient andwould allow a more rapid evolution of Medicare benefits toward those needed for proper chroniccare.

Jeff Lemieux is senior economist at the Progressive Poilicy Ins titute.

Endnotes' Lemieux, Jeff, David B. Kenda5, Kerry Tremain, and S. Robert Levine, M.D., -An 'ABC' Preposal to ModernizeMedicare," Pngressiur Paticy Itntitute, February 14, 2003, ioi-ar.ppiontine.org. Kendall, David B., Kerry Tremain, JeffLemiris, and S.Robert Levine, M.D., 'Health Aging v Chronic ltnels Preparing Medicare fr the Neat H-Iath CareChallenge,' Progressive Policy Institute, February 14, 2003M, mi.ppionlin- org.I Bocruti, Cristina end Marilyn Moon, Comparing Medicare and Pnvrte Insurers: Gro-th Rates in Spending OverThree Decades,- Health Affairs, March/Apnl 2003, -heaulthatftia-rs.org Antos, Joseph R., with Alfredo Goybur.,Comparing Medicare and Povate Health Insurance Spending," The Heritage Foundation, Webmemo #250,wrovro hrdtage.org

For more inbntnrtion about this or any other PPIpublication, please contact the Publicalions Drpartment at: (202)547-0001, write Progressive Policy Institute, 600 Pennsyltrania Aenue SE, Suite 400, Washington, DC 20003, or visit oursite on the Web at http'A unippionline.org.

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The CHAIRMAN. Thank you all very much for your testimony thismorning.

Let me ask questions that all three of you may respond to if youwish. The first one, I would suggest, is taking everything into con-sideration-cost growth, benefit packages, and flexibility-who isgetting greater value for each dollar spent on his or her health careat this time-a Medicare beneficiary or a person covered under atypical private insurance plan, and why is this the case?

Ms. MOON. I will go first and say I think it would be Medicare,because Medicare has remained truer to a benefit package with ac-cess to providers of services over time. It is much easier to staywith the same physician.

Joe Antos tells us, for example, that you can change doctors ina PPO. But to see the doctor that I have seen for 10 years undermy PPO, I pay a 65 percent copay, not because of the stated copay-ment but because of what the PPO determines is usual, customaryand reasonable. You cannot find out this amount before the fact.I know; as a good consumer, I have tried-from Care First, becausethat is proprietary.

That is one of the reasons. I also believe that over time, thereare probably a lot of counterbalancing influences. The managedcare reaction and then reaction against in terms of many people re-jecting the very tight controls that some managed care plans puton individuals, often in arbitrary fashion, meant that there was adeterioration in some of the benefits that people received.

The reason that I undertook the study to show that there is nota lot to assume that the private insurance market will just in-stantly solve Medicare's financing problems. This was to counterthe argument that some people have made that you can just putMedicare beneficiaries into private plans, and poof-everything willbe wonderful. I think both sides have a struggle to hold down costs,as Jeff Lemieux said.

The CHAIRMAN. Joe.Mr. ANTOs. Mr. Chairman, believe it or not, I agree with Marilyn

but not for the reasons she gives. Marilyn is actually, I think, prob-ably typical of most people in private employer-sponsored planstoday. They do not have any choices. That is not the kind of re-form-

Ms. MOON. Actually, I have a choice of 14 plans; all of them arecrappy. [Laughter.]

Mr. ANTOs. OKThe CHAIRMAN. You are not in that high rate of general ap-

proval.Ms. MOON. Satisfaction-no, I am not.The CHAIRMAN. All right.Mr. ANros. You have a choice of 14 plans, and you do not like

any of them. There is a considerably wide range of choice in theFederal Employees Health Benefits Program, and as Walt Francissaid, "The level of satisfaction is very high."

But my point is let us not talk about ourselves-let us talk aboutthe average American worker. The average American worker doesnot have a choice of plans. The average American worker has theplan that is settled upon by the employer. Typically, if there ap-pears to be a choice, it is three flavors of the same kind of plan.

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That is not a good situation. Medicare beneficiaries would do betterunder a Federal Employees Health Benefits type of system wherethere is a much wider range of choices and where there is, frankly,the kind of Federal oversight that is going to be necessary for thispopulation. Many of these people are frail and have difficulties gen-erally with their health and may need some greater protection.That is why we have the Medicare Program in the first place. Thatis how it could work under a FEHB style of reform.

On balance, however, people walk with their feet, and they talkwith their money. Over 90 percent of Medicare beneficiaries getsome kind of supplemental coverage. More than 25 percent of themhave to buy some form of coverage, and 10 million of them spendan average of $1,700 a year to make up for the inadequacies asthey see it in the Medicare Program.

The CHAIRMAN. Jeff.Mr. LEMIEUX. Well, Mr. Chairman, I think Marilyn is going to

say that Medicare is a better value, and Joe is going to say thatchoices are good and that private options are a better value, andI am going to say that there is no way that any committee of Con-gress could determine which sector has the better benefits and val-ues intrinsically and that therefore, choice is probably the best ap-proach; allow people to choose.

What we need to do in Congress is set up the oversight struc-tures, set up the consumer information to make sure that the con-sumer protections are there so that whatever choices people makewill be decent ones, sort of like what Federal employees make.

The CHAIRMAN. In other words, you are suggesting that all willbe served better in the health care environment if there is a clearcompetitive market between Burger King and McDonald's?

Mr. LEMIEUX. In general, yes, that sort of competition and choicetends to lead to innovation and progress that is probably a lesserror-prone and awkward way of making progress than we havemade it in Medicare over the last years with responses to privateinnovations and back and forth in a political way.

The CHAIRMAN. Thank you.Senator Carper.Senator CARPER. Thanks, Mr. Chairman. I enjoyed being a back-

bencher earlier for a brief while.The CHAIRMAN. Well, we appreciate you attending this morning.Senator CARPER. My pleasure. Thanks for holding the hearing.

By the way, was a very good panel. I missed most of the first panel,but I know some of these people pretty well and am very gratefulto you and our staff for bringing them all together. They havegiven us a nice menu of ideas.

I am going to start with Jeff Lemieux and ask him if he will tojust talk a little bit about what the Progressive Policy Institute be-lieves we should do with respect to Medicare reform.

Mr. LEMIEUX. We have a three-point plan, perhaps not too clev-erly labeled the "ABC Plan." The "A" part of the plan is an attemptto create in the fee-for-service program the sort of accountability-"A" stands for accountability-system that would allow the fee-for-service plan to modify its benefits and its payment systems in away so that it could compete and evolve and innovate within thefee-for-service plan.

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Senator CARPER. If you could hold for just a second, for our otherwitnesses, Dr. Moon and Dr. Antos, I am going to ask you to cri-tique this for us, so if you do not mind, I just want to give you aheads-up.

Thanks. Go ahead, Jeff.Mr. LEMIEUX. So point No. 1, accountability, is making within

the fee-for-service program and within Medicare as a whole a wayto allow the Medicare administrators to evolve more quickly with-out congressional directive and to improve things.

"B" is a benefit package. We are advocating that the most prac-tical form of a Medicare prescription drug benefit would be a zeropremium catastrophic benefit available to all Medicare bene-ficiaries under Part B, that this would be universal-everyonewould get some sort of Medicare catastrophic benefit card, eitherthrough a supplemental insurer or as a discount card-and therewould also be an extra program for low-income beneficiaries whohave incomes too high to qualify them for Medicaid but too low toreally benefit much from a catastrophic benefit.

The third element is choices. We think that the sorts of choicesthat have been put forward in terms of additional PPO options andexpanding that demonstration nationwide and to fix up the HMOprogram so that Senator Stabenow's mother has a choice backthere in Michigan or wherever she lives, that these are good thingsand that they should ultimately lead in the direction of an FEHB-style competitive system over time.

So it is accountability, benefits, and choices.Senator CARPER. Thanks.Mr. Antos.Mr. ANros. I think those are great principles. The details matter.

The details matter a great deal. I have got to say that I am notas familiar with the ABC Plan as Jeff is, so correct me, Jeff, if Iget something wrong here. But I guess the thing that I would focuson, the thing that I at least know a little bit about, is the idea ofhaving a universal zero premium drug benefit type of plan. I thinkthere are some aspects of that that are very good, but ultimately,there are concerns that I would have especially about the way thatthat might run.

As I say, this is my interpretation, and I am not sure I am get-ting it right, but the concern that I would have is that, as I under-stand the proposal, there would be the appearance of competition.I think this has been characterized as that virtually any kind of or-ganization could offer this drug benefit to Medicare beneficiaries,including current Medicare carriers, Medicare HMOs in the M PlusC program, or employer groups, or you name it-presumably asso-ciation health plans, something like that.

That sounds good, but this is a program, as I understand it,where the government would take all of the financial risk, and Ithink that ultimately, this is of great concern. One of the principlesof market competition is that the plans have to have skin in thegame; otherwise, they cannot get very interested about trying tocontrol costs if all of their costs are covered ultimately by the Fed-eral Government, by whom I mean the taxpayer.

There is a great risk if we have a drug benefit program where100 percent of the risk is borne by the taxpayer. There is a great

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risk that Congress in its due diligence to assure that the taxpayeris not paying too much decides that we have to have some kind ofa national drug pricing scheme to make sure that everything is fairand to make sure that all beneficiaries are treated fairly and theyreach their catastrophic cap, the uniform national cap, at the sametime as anybody else.

It sounds like equity, but it has the seeds, I think, of potentialdisaster. I think this is part of the plan that I would hope that Jeffand others would work on much more carefully to try to preservethe kinds of market incentives that now exist, especially in -thedrug benefits business, to encourage drug benefit organizations toaggressively manage the benefits, aggressively seek out discountsand rebates from pharmaceutical manufacturers and to tailor theirbenefit to best meet the needs of the beneficiaries.

Senator CARPER. Thank you, Dr. Antos.Mr. Lemieux, would you like to respond to any of the comments

that Dr. Antos has made?Mr. LEMIEUX. Yes. I believe that his concerns are greatly over-

wrought. Some of them are valid, but they are generally greatlyoverwrought.

Senator CARPER. Dr. Antos, have you ever had that accusationleveled at you before?

Mr. ANTOS. No. I am considered a very calm guy.Mr. LEMIEUX. I do not know, Senator, if you want us to debate

each point by point, but I think that in general-Senator CARPER. As a matter of fact, I would, but we do not have

time for that-just a couple of points, if you would.Mr. LEMIEUX. I think in general that beneficiaries would still be

responsible for copayment even after they have hit the catastrophiccap, so that should help restrain costs. All such plans would haveto be approved by CMS to make sure that they are doing a fair job,a good job, by getting discounts for their beneficiaries and thereforealso for the taxpayer. Employers certainly would not be anxious tosuddenly go lax when their retirees suddenly got to a point wherethe government was reimbursing. We also favor risk corridors,other sorts of performance based approaches with the government,to make sure that all these plans would have a good incentive tosave money.

On the equity issue, I really think that that is a very, very smallissue and that any sort of pluralistic health care program run bygovernment is going to have some people having slightly betterbenefits than others in certain different ways, but I think that thatsort of diversity and plurality is generally a good thing that willnot cause mischief.

Senator CARPER. Thank you.Dr. Moon, your reaction to what Mr. Lemieux has just laid out,

please.Ms. MOON. I would say first of all that a number of the principles

that he is talking about are desirable ones. But I am not sure thatI would go the direction that he would in all cases.

Medicare does need considerably more flexibility in terms of run-ning and managing the basic program, the traditional part of theprogram, but I would be very cautious about-

Senator CARPER. Does that mean you endorse the "A" in ABC?

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Ms. MOON. Well, I would be very cautious, though, about doingit differentially at the local level. We have a lot of concerns aroundthe country already about differential treatment of Medicare bene-ficiaries, and that is something that needs to be looked at veryclosely. But I do think that finding ways to be more flexible andto have less micromanagement is definitely a good idea.

On the benefits side, certainly my preference would be a well-rundrug benefit program that is an integral part of the rest of the ben-efits. I think it is a mistake to try to pull it out. That is true forwhether the drug benefit is in a private plan or in the traditionalMedicare Program.

For one thing, the risks that occur in terms of the costs of insur-ance are much better blended together, because high users of drugsare not necessarily high users of the rest of health care, and youcan pool the risks better that way.

You would also have to be very careful to have better protectionsfor those with low incomes than it is my understanding that hisplan has. You need to recognize that if you go as far up the incomescale in order to cover people in need, you are going to be talkingabout perhaps half of the population being covered. It may be dif-ficult to be that generous.

Finally, in terms of the choice issue, I think that he is on theright track. We should encourage more private participation, butfocus it in areas where there is supposed to be innovation, and thatis in disease management and coordination of care. We have seentoo little of such innovation in Medicare+Choice and in many of thecommercial HMOs and PPOs. That is where I think you wouldneed to challenge them to do more.

Senator CARPER. My time has expired; otherwise, I would askMr. Lemieux to respond if he wanted to.

The CHAIRMAN. Please go ahead.Senator CARPER. Do you have any response to what Dr. Moon

has said?Mr. LEMIEUX. I am pleased that that sounded like a partial bit

of endorsement that I appreciate a great deal. I think I agreegreatly that benefits to the extent possible should be linked and co-ordinated if possible under one plan, and if not possible, theyshould be linked with information systems that allow people run-ning these sorts of benefit programs to evaluate tradeoffs. If I havea little bit better drug benefit over here, will I save money in hos-pitalization over here?

The only other point I wanted to mention-we have spoken a lotabout the New York Times article this morning and how it saysthat private fees are higher-I think there more to it than justfees, and that is a trap we fall into when we are congressional esti-mators and policy wonks around town, that there is price and thenthere is quantity, and then there is quality, and these things allgo together to form how much we actually spend on something, andjust because a fee is higher or lower may not be indicative of thewhole mix of spending that goes on behind that. I just wanted topoint that out.

Senator CARPER. Thank you.Mr. Chairman, I will finish up where I started off. This is a good

panel, and I do not think it would be possible to get the three of

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them to agree on what we ought to do, but if we could, I would en-dorse it.

Thanks very much, and my thanks to all of you.The CHAIRMAN. Tom, thank you.I have a couple more questions of you, and all three can respond.

Critics of any form of competitive model seem to worry that healthplans will pick and choose the healthiest patients.

We have also heard FEHB say this does not really happen, or ithappens very little. What do you think of this adverse selectionproblem, and can you address it?

Is this a red herring in the arguments, or is that a legitimateconcern, the issue of adverse selection?

Ms. MOON. I think you raise a very good point. I would say thatone of the things that makes FEHBP work relatively well is thata large number of individuals are willing to shift plans. But studiesof seniors have shown they are much less willing to do so. In fact,in the FEHBP a few years ago, when there was a high-option BlueCross/Blue Shield, plan people stayed in those plans even thoughwhen Medicare was primary they did, they got not one penny morein benefits by paying the substantial additional premiums. Peopledid not want to shift because they were comfortable, as you said,with what they have. Since choice to make bad decision is also afunction of the market; then you let people be in those situations.

Similarly, if there is risk selection, it means that the people whoare reluctant to leave are going to stay in the plans that get to behigher and higher cost over time, which is exactly what happened.So there has been some risk selection in FEHBP.

It is also the case that FEHBP has less risk selection, becauseover time, the plans tend to eliminate things that attract highrisks. We have seen that in terms of some of the mental healthbenefits, for example, in the past. In 1990, for example, OPM toldeveryone they had to have drug benefits.

So it is not as if not intervention is needed. I agree with Joe thatthere are some things that you can do. But one of the problemswith competition is how much control you want to place on it. Ina purely competitive market where you are going to get the bestprice competition, you do not want much variation in benefits, be-cause you want people to choose only on the basis of price. If youare going to allow them to choose on the basis of benefits, you aregoing to have a lot more variation and a lot less lower potential forsavings.

So there are a lot of decisions that need to be made, in terms ofthinking about this.

The CHAIRMAN. Mr. Antos.Mr. ANTos. This is a very complicated issue. Your point is abso-

lutely correct that we have to distinguish between the normal func-tioning of people making choices, just as they do when they go tothe supermarket or when they buy automobiles, from the adverseconsequences of a poorly designed health program. We ought tokeep those distinctions very separate and very clear.

What we do want to do is prevent a system from causing bigproblems for our seniors, but we also do not want to prevent ourseniors from exercising their judgment about how they want tohandle their health care.

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The FEHB story is a complicated story, but I think there are sev-eral clear bottom lines to it. One is that it is a government pro-gram; Medicare will always be a government program; governmentoversight is very important.

Second, FEHB provides a very generous premium subsidy justlike Medicare.

Third, FEHB exercises considerable oversight over the program,as Marilyn pointed out, but they do it at considerably less adminis-trative cost than Medicare does.

Fourth-and this is the question that you were alluding to aboutif people do not move and how does this work out-FEHB actuallytakes advantage of the competitive market incentives that are inplace for that program that are fundamentally not in place inMedicare. An operating competitive market does not requiremasses of people to bolt from their health plans every year. In fact,that would be disruptive. If that happened, that would not be awell-functioning competitive market.

In other markets, there is plenty of brand loyalty. I have my fa-vorite brand of cereal-I guess it is Rice Krispies. I buy that everytime. I am very loyal to Rice Krispies, but that does not mean thereare not 20 other varieties of cereal out there.

Why are there other varieties of cereal? Because there are peoplewho are closer to the edge on how they feel about Rice Krispies,and maybe they want sugar in their cereal without having to adda spoonful.

The CHAIRMAN. It is the noise.Mr. ANTOS. Yes, exactly right.That is the point. Of course, we can stay with government con-

trols. We have done that for 30 some-odd years now. The questionis does that mean that Medicare beneficiaries will really be able tomake their preferences known in an effective way. I think the pre-scription drug debate demonstrates that that is not the case, andit cannot be the case.

The CHAIRMAN. Jeff.Mr. LEMIEUX. To your point on adverse selection, I do think it

is a serious issue. I think it goes both ways. In the past, we alwaysused to say that private health plans were always going to seek outthe cheaper people, and I think that as the Medicare HMO experi-ment has played out, they have ended up with some very, very sickpeople from low-income neighborhoods especially in the MedicareHMO program.

So I think that adverse selection problems go both ways. It is away to protect the fee-for-service plan from getting too many sickbeneficiaries. It is also a way to protect private plans from gettingtoo many sick beneficiaries without due compensation.

I do believe that the sorts of risk adjusters that have beenworked on for the last 20 years are gradually getting better, andI also believe that if we had a universal catastrophic drug benefitso that the risk adjusters would know which sorts of medicationspatients are on-anonymously, of course-but for the purposes ofrisk adjustment, that would be a very powerful, instantaneous sortof real-time tool for adjusting payments to health plans based onthe diagnoses and illnesses of the beneficiaries they serve.

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The CHAIRMAN. Time is going to demand that this be my lastquestion, but let me ask this of all of you.

Assuming for a moment that Congress does decide to incorporatea competitive component in the Medicare reform legislation, arethere particular features that you think we should include to maxi-mize effective cost restraints while still fostering quality and fullaccess?

Ms. MOON. First of all, I believe you have to have a good basicbenefit package that every plan must adhere to, including tradi-tional Medicare. Prescription drugs' absence is one of the thingsthat really caused problems to Medicare+Choice plans. They werebeing paid enough to provide Medicare-services, but they were notbeing paid enough to provide a good benefit package. So that is anessential piece, and it could even be a first piece before you moveto expand private plans.

I think there will need to be a considerable amount of account-ability, and I think people who think that you can operate with the140 people that OPM does are fooling themselves, because for onething, these choices are going to be individually offered to peopleall over the country without the mechanism that the Federal em-ployees now have to work with their own benefits offices to sortthrough their choices. So there will need to be a lot more oversightand considerably more effort and information efforts to help peoplemake wise choices.

Finally, I think there needs to be a lot better appeals process andinformation for people than we have under the current M Plus Cprogram. For example, today a problem can be resolved for a bene-ficiary who is being denied care inappropriately by an M Plus Cplan, but there is no follow-up to make sure that every other bene-ficiary gets that same treatment by the same managed care plan.People who do this kind of counseling will tell you that they willget the same problem from the same HMO at the same location sixand seven and ten times and not get it resolved except on a pa-tient-by-patient basis.

There are a number of things that ought to be put in place thatwill not get government out of the business, and in fact those inCongress who think that folks will stop beating down your door ifyou turn Medicare over to the private sector would have a rudeawakening in the not-too-distant future.

The CHAIRMAN. Thank you.Joe.Mr. AN'rS. I think the issue is not just cost, but also one of

value, and I do not think we want to lose that important theme.So that, yes, it is important to include many of the features thatI think Marilyn is talking about-to try to maximize the ability ofthe entire system to slow down the growth in cost; however, thatis where the private competitive market really comes into play.

I think the real emphasis that I would place is to look carefullyat what needs to be done to have prudent and appropriate competi-tion. That does not mean that the government can let its guarddown. After all, the health market is far from a purely competitivemarket, so there are some real issues there related, for example,to antitrust. There are all sorts of very complicated policies that

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are probably not normally considered when people think aboutMedicare reform that have to be dealt with.

Nonetheless there are some important things. I think the mostimportant thing is to assure that beyond those basic safeguard, wemodernize the program. Medicare beneficiaries in the fee-for-serv-ice program should be exposed to reasonable incentives even intheir program to use services wisely. That does not mean an $840first day payment for a hospital visit. People do not go to the hos-pital because it is a voluntary act. It probably does mean a largercombined deductible, larger than the $100 Part deductible. It al-most certainly means more reasonable cost-sharing arrangementsacross all of the services.

Those sorts of things can enlist the individual beneficiary in bothseeking better care for themselves and being on the side of the tax-payers-they are taxpayers, too-being on the side of the taxpayersto use those resources prudently.

The CHAIRMAN. Joe, thank you very much.Jeff.Mr. LEMIEUX. Mr. Chairman, I think if you do decide to go with

stepping stones toward an FEHB system in a Medicare reformpackage this year, you will have to do some communication withpeople, because the way the current baselines are set up by theCongressional Budget Office and the Joint Committee on Taxationis that we fundamentally understate the amount of spending thatwe are likely to do in our current baseline, including on Medicare,because we presume that rules that require us to cut physicianpayments for years on end and so on actually go into place.

Then, we overstate the revenue we are likely to receive becausewe assume that various sunset provisions actually occur, when weall know that drafters of tax law do not intend for sunset provi-sions to occur.

So from a baseline perspective, it looks like anything you do tofix Medicare is going to cost a lot of money; the baseline is alreadytoo low. However, we will have to explain to people that we aregoing to spend some money according to these budget accounts inthe short run in an attempt to create a situation that, 10 or 20years down the road, will give us a slightly lower rate of growthto the program and help provide better value.

So I think that when you come back with cost estimates sayingthat we are improving our private plan options in Medicare, andit is costing us a fair amount of money in the short run, that thathas to be balanced with a 10- or 20-year analysis of how that couldgradually save money in the longer period.

That is my only comment about putting an FEHB plan in thisyear and what it might mean.

The CHAIRMAN. To all three of you, thank you very much for yourtime this morning, your testimony, your commitment to the issue,and serving as a resource for this committee and for Congress aswe work our way through this issue.

Thank you very much, and the committee will stand adjourned.[Whereupon, at 11:56 a.m., the committee was adjourned.]

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